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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
(X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 (No fee required effective October 7, 1996)
For the fiscal year ended January 30, 1999
( ) Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition Period from _______________ to _________________.
Commission file no. 0-19536
THE RIGHT START, INC.
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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.)
5388 Sterling Center Dr., Unit C, 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
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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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of April 19, 1999, approximately 2,595,487 shares of the Registrant's Common
Stock held by non-affiliates were outstanding and the aggregate market value of
such shares was approximately $17,519,537.
As of April 19, 1999 there were outstanding 5,051,820 shares of Common Stock, no
par value, with no treasury stock.
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The Company has prepared this Form 10-K/A to provide the information required
to be included in Part III hereof.
This Annual Report on Form 10-K contains "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Discussions
containing such forward-looking statements may be found in the material set
forth under Item 1. Business and Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations, as well as within this Annual
Report generally (including any document incorporated by reference herein).
Also, documents subsequently filed by the Company with the Securities and
Exchange Commission may contain forward-looking statements. Actual results
could differ materially from those projected in the forward-looking statements
as a result of the risk factors identified herein or in other public filings by
the Company, including but not limited to, the Company's Registration Statement
on Form S-3 (File No. 333-08175).
PART I
ITEM 1. BUSINESS
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General
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The Right Start, Inc., a California corporation ("The Right Start" or "the
Company") is a leading merchant offering unique, high-quality products for
infants and young children. The Company markets its products through 41 retail
stores and through The Right Start catalog. The Company is a market leader
offering approximately 800 items targeting infants and children from pre-birth
up to age four. Products offered are carefully selected to meet parents' baby
care needs in such categories as Travel, Developmental Toys, Books/Music/Video,
Feeding, Nursery, Health/Safety and Bath/Potty.
History
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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 the formation of the Company, new parents' alternatives
were low-service mass merchandise stores or sparsely-stocked, high-priced
infants' and children's specialty stores. To counter this, The Right Start
carefully screened infant and toddler products in order to identify those
considered to be the "best of the best," that is, the safest, most durable, best
designed and best valued items.
The Right Start then expanded its distribution channel beyond The Right Start
Catalog and into specialty retail sales through The Right Start stores. Based
on the results of the retail stores, the Company's strategy evolved to include a
reduction in The Right Start Catalog circulation and plans for a major retail
expansion.
Management has always made customer service the Company's highest priority.
By offering to its customers sales associates with extensive product knowledge,
carefully selected and tested products, fast shipment that is generally less
than 48 hours from receipt of catalog orders, and a 24 hour a day/365 day a year
ordering availability, The Right Start is able to differentiate itself from its
competitors.
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Retail Operations
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On January 30, 1999, the Company had 40 stores in operation. The stores'
product mix includes a wide variety of items to meet the needs of the parents of
infants and small children, all presented within a store designed to provide a
safe, baby-friendly environment for the shopping ease of new parents.
The number of stores open reflects the rapid growth that the Company
experienced in 1996 and early 1997, during which time 24 mall stores were
opened. After studying the results of both mall and street locations, management
concluded that street locations represented a much more appropriate format for
future retail growth. These locations are more convenient to access and shop
for the Company's customers, many of whom are shopping with infants and small
children. Further, street locations are more cost efficient to build and
operate. Accordingly, the Company adopted a store opening plan which provided
for the opening of eight street-location stores in 1998.
In addition to reevaluating store location strategy, in 1997 the Company
determined that certain existing mall locations were not performing at an
acceptable level and implemented a store closing plan. Nine mall stores were
closed in 1998.
The Right Start Catalog
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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 an average annual income in excess of $60,000.
Advertising and Marketing
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The Right Start has implemented a number of national, regional and local
marketing programs to reinforce its strong brand name and increase customer
awareness of customers in new store locations. These programs include print ads
in national and regional publications, direct mail and local newspaper
advertising. In addition, the stores' point of sale system provides a strong
marketing database. Customers' names and addresses are captured and are then
used for promotional mailings and other follow up activities. Further, the Right
Start catalog provides effective marketing support for the stores. Catalogs are
distributed in existing and future retail markets to a targeted customer base.
The Company reaches its catalog customers through mailings of The Right Start
catalog to qualified segments of the Company's own customer list and selected
rented lists. In order to achieve this efficiently, the customer list is
segmented by frequency, recentcy 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 500 different vendors. No single
vendor represents more than 5% of overall sales. In total, the Company imports
approximately 5% of the products offered. Imported items have historically had
higher gross profit margins and tend to provide more opportunities for the
Company to offer a large selection of unique goods.
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Employees
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As of April 19, 1999, the Company employed 327 employees, approximately 57
percent of whom were part-time. The Company's employees have not entered into
any collective bargaining agreements nor are they represented by union. The
Company considers its employee relations to be good.
Recent Developments
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The Company continues to develop its plan to engage in electronic commerce
over the Internet. The Company has been developing its e-commerce Website,
RightStart.com, Inc., as subsidiary of the Company, that will own and operate
the Internet portion of the Company's business. The Company's plans call for
RightStart.com to be operational by mid-summer 1999. The Company plans to
capitalize on its valuable brand name and knowledge and expertise in children's
specialty retailing, developed through its retail store and catalog operations,
to successfully launch RightStart.com in the Internet arena.
The Company has engaged a financial advisory firm to advise it on its e-
commerce strategy and to assist the Company in funding and financing
RightStart.com. The financing will likely consist of the sale of a minority
stake in RightStart.com to strategic investors. The Company is currently in
negotiations with prospective investors regarding the size, terms and conditions
of such investment, although the Company has not yet entered into any
contractual arrangements with any such prospective investors.
Competition
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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-intensive
environment.
There are a variety of general and specialty catalogs selling infants' and
children's items in competition with The Right Start catalog. The Company
considers its primary catalog competition, however, to be "One Step Ahead,"
"Kids Club" by Perfectly Safe, and "Sensational Beginnings." These catalogs
emerged several years after The Right Start catalog and directly compete by
offering a very similar product line at comparable price points to the same
target market.
New entrants to The Right Start's competitive landscape include several e-
commerce sites that sell infants' and children's products on -line. These
entities are generally newcomers in the infant and children market and the
Company believes that such entities for the most part, do not have the brand
recognition or relationships necessary to quickly gain marketshare. The Right
Start expects that its e-commerce Website, RightStart.com, will be operational
during mid-Fiscal 1999. The Company believes RightStart.com will be able to
differentiate itself from its competitors by drawing on the Company's extensive
knowledge of retail sales of products for infants and children to its target
market.
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Trademarks
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The Company has registered and continues to register, when deemed appropriate,
certain U.S. trademarks and trade names, including "RightStart.com", "The Right
Start", and "The Right Start Catalog." The Company considers these trademarks
and tradenames to be readily identifiable with, and valuable to, its business.
ITEM 2. PROPERTIES
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At January 30, 1999, The Right Start operated 40 retail stores in 15 states
including California, Colorado, Massachusetts, Minnesota, New Jersey, Illinois,
Pennsylvania, New York, Connecticut, Michigan, Washington, Missouri, Virginia,
Maryland and Ohio. The Company leases each of its retail locations under
operating leases with lease terms ranging from six to ten years, including
provisions for early termination in most locations if certain sales levels are
not achieved. At certain locations, the Company has options to extend the term
of the lease. In most cases, rent provisions include a fixed minimum rent plus
a contingent percentage rent based on net sales of the store in excess of a
certain threshold.
The Right Start currently leases approximately 11,000 square feet as a sub-
tenant in a mixed-use building in Westlake Village, California. The Company's
corporate office resides in this space. The sub-lease agreement terminates in
September 1999. The Company is currently negotiating with its landlord to
extend the lease term.
ITEM 3. LEGAL PROCEEDINGS
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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 significant merit. The Company
believes that the ultimate outcome of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
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Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDERS'
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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 common stock is held of record by
approximately 121 registered shareholders as of April 19, 1999. The following
table sets forth the range of high and low bid prices on the Nasdaq National
Market for the Common Stock for the periods indicated. The bid price quotations
listed below reflect inter-dealer prices without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
Bid Price (1)
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Fiscal 1998 High Low
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<S> <C> <C>
First Quarter $4.50 $2.75
Second Quarter 3.75 1.75
Third Quarter 2.75 1.50
Fourth Quarter 4.50 2.00
</TABLE>
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<TABLE>
<CAPTION>
Fiscal 1997
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<S> <C> <C>
First Quarter 5.50 2.13
Second Quarter 3.38 2.25
Third Quarter 3.50 2.38
Fourth Quarter 2.69 1.75
</TABLE>
(1) Bid prices have been restated to give effect to the Company's one-for-two
reverse stock split which was reflected on Nasdaq at the opening of trading
on December 16, 1998.
The Company has never paid dividends on its common stock and currently does
not expect to pay dividends in the future. In addition, the Company's credit
agreement contains a number of financial covenants which may, among other
things, limit the Company's ability to pay dividends. See "Management's
Discussion and Analysis of Financial Condition and Results of Operation."
ITEM 6. SELECTED FINANCIAL DATA - (Dollars in thousands except share data; all
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share data has been restated to give effect to the Company's one-for-two reverse
stock split which was effective December 15, 1998)
<TABLE>
<CAPTION>
33-Week
Transition
Fiscal Year Period Fiscal Year
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1998 1997 1996 1995
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<S> <C> <C> <C> <C> <C>
Earnings Data
Revenues:
Net sales $ 36,611 $ 38,521 $ 27,211 $ 40,368 $ 44,573
Other revenues 877 214
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36,611 38,521 27,211 41,245 44,787
Net loss (5,680) (9,241) (5,378) (3,899) (2,106)
Basic and diluted loss (1.13) (2.01) (1.34) (1.19) (0.66)
per share
Share Data
Weighted average shares
outstanding 5,051,820 4,594,086 4,003,095 3,268,407 3,150,000
33-Week
Transition
Fiscal Year Period Fiscal Year
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1998 1997 1996 1995
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Balance Sheet Data
Current assets $ 8,300 $ 8,908 $ 11,704 $ 8,353 $ 9,660
Total assets 17,671 18,462 22,982 17,475 14,632
Current liabilities 6,572 4,796 8,457 4,649 3,690
Long-term debt -- 8,734 5,643 -- --
Shareholders' equity 7,861 3,307 7,172 11,902 10,694
</TABLE>
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
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RESULTS OF OPERATIONS
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Recapitalization
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In order to enhance the Company's liquidity and improve its capital structure,
effective April 13, 1998 the Company completed a private placement of non-
interest bearing senior subordinated notes in an aggregate principal amount of
$3,850,000, together with detachable warrants to purchase an aggregate of
3,850,000 shares of common stock exercisable at $2.00 per share. The new
securities were sold for an aggregate purchase price of $3,850,000 and were
purchased principally by affiliates of the Company. In connection with the sale
of the new securities, the Company entered into an agreement with all of the
holders of the Company's existing subordinated debt securities (the
"Agreement"), representing an aggregate principal amount of $6,000,000.
Pursuant to the Agreement, each holder (of new and old securities) agreed to
exchange all of its subordinated debt securities, together with any warrants
issued in connection therewith, for newly issued shares of preferred stock. Ten
shares of newly issued preferred stock were issued for each $1,000 principal
amount of subordinated debt securities exchanged. The total number of shares
issued were 30,000, 30,000 and 38,500 for Preferred Stock Series A, B and C,
respectively. Holders of $3,000,000 principal amount of existing subordinated
debt securities elected to receive Series A Preferred Stock which has no fixed
dividend rights, is not convertible into common stock, is mandatorily redeemable
by the Company in May 2002 and will not accrue dividends unless the Company is
unable to redeem the Series A Preferred Stock at the required redemption date,
at which point dividends would begin to accumulate and accrue at a rate of $15
per share per annum. Holders of $3,000,000 principal amount of subordinated
debt securities elected to receive Series B convertible preferred stock which
has no fixed dividend rights and is convertible into common stock at a price per
share of $3.00. Holders of the $3,850,000 principal amount of newly issued,
non-interest bearing senior subordinated notes exchanged such debt securities
(and the warrants issued in connection therewith) for Series C convertible
preferred stock, which has no fixed dividend rights and is convertible into
common stock at a price of $2.00 per share. The issuance of the shares of
preferred stock occurred upon exchange of the subordinated debt securities in
December 1998.
Results of Operations
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This discussion should be read in conjunction with the information contained
in the Financial Statements and accompanying Notes thereto of the Company
appearing elsewhere in this Form 10-K.
Results for the Transition Period (the 33-week period from June 2, 1996 to
February 1, 1997) have been presented and discussed to provide the reader with
an understanding of the Company's financial condition and results of operations.
Comparisons have been made, based on the significant operating factors in each
period, between the current fiscal year and Fiscal 1997, between Fiscal 1997 and
the comparable unaudited 52-week period of the prior year and between the
Transition Period and the comparable period of Fiscal 1996.
Fiscal 1998 Compared With Fiscal 1997
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Revenues for Fiscal 1998 were $36.6 million compared to $38.5 million for
Fiscal 1997. Retail net sales were $31.9 million in Fiscal 1998 and $31.1
million in Fiscal 1997; catalog net sales were $4.7 million in Fiscal 1998 and
$7.4 million in Fiscal 1997. Retail net sales increased $.8 million or 2.5%,
reflecting the impact of same-store sales increases of 6.5% and the opening of
eight new street location stores, offset by the impact of eleven store closures.
The 36.1% decline in catalog sales resulted from the Company mailing fewer
catalogs in accordance with its operating plan.
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Cost of goods sold represented 50.7% of sales in Fiscal 1998 compared to 50.0%
of sales in Fiscal 1997. The slight decline in gross margin resulted from the
additional markdowns taken in conjunction with the closing of certain mall
stores and from the conversion of three of the Company's remaining mall stores
to a discount format. The discount store format was adopted in three poor
performing stores in an effort to better meet the demographics of the customers
in those markets.
Operating expense decreased $3.9 million or 20.3% in Fiscal 1998 from $19.2
million in Fiscal 1997 to $15.3 million in Fiscal 1998. Catalog operating
expenses decreased 46% or $1.9 million in Fiscal 1998 as compared to Fiscal 1997
in conjunction with the reduction in catalog mailings and reduction of
production costs on a per-catalog basis. Retail operating expenses declined 13%
or $2.0 million in Fiscal 1998 as compared to Fiscal 1997. The retail
reductions include $.5 million of occupancy costs related to store closings
(offset somewhat by street location openings), $.8 million of distribution cost
reductions and $.7 million of payroll and other operating cost reductions.
These reductions reflect management's attention to expense management.
General and administrative expense decreased 11.6% to $3.5 million in Fiscal
1998 as compared to $3.9 million in Fiscal 1997. The decrease was primarily due
to payroll and occupancy cost reductions in conjunction with management's
ongoing expense management.
Preopening costs decreased $.5 million from $.7 million in Fiscal 1997 to $.2
million in Fiscal 1998. The reduction was due to the reduction in preopening
costs per store opened as well as the impact, in Fiscal 1997, of the Company's
previous policy of recognizing store opening costs evenly over the stores' first
twelve months of operations for the stores opened in 1996. In the third quarter
of Fiscal 1997, the Company changed its method of accounting for pre-opening
costs and began expensing them as incurred.
Depreciation and amortization expense decreased $.1 million or 7.5% in Fiscal
1997 to $1.5 million in Fiscal 1998. The decrease resulted from the closure of
eleven stores, most of which were closed during the first half of Fiscal 1998,
offset by the depreciation expense recognized on assets for the eight new stores
opened in the second half of the fiscal year.
Other income of $.1 million in Fiscal 1998 is comprised of net revenues
generated from store closings. In December 1997, the Company's Board of
Directors approved management's plan to close seven poor performing retail
stores. Six of these stores were closed as of April 1999 and the remaining
store is in the process of being closed as of April 1999. Such closures
generated positive revenues for the Company resulting from the recovery of the
value of certain of the leases through either landlords or future tenants of the
leased space. In the prior year, other expense of $1.9 million include $1.3
million of fixed assets and leasehold improvements written off in conjunction
with planned store closures, $.4 million in fixed assets and leasehold
improvements written off in conjunction with the Company's corporate office and
distribution center moves and $.2 million of severance expense.
Non-cash beneficial conversion feature amortization expense of $3.9 million
represents the one-time expense recognition associated with the issuance of the
Company's Series C convertible Preferred Stock in connection with the Company's
recapitalization, as discussed above.
Interest expense decreased $.5 million from $1.1 million in Fiscal 1997 to $.6
million in Fiscal 1998. The 44.0% decrease results from the restructuring of
the Company's subordinated debt to eliminate interest on that debt and lower
overall borrowings.
The Company has a deferred tax asset of $9.1 million, which is reserved
against by a valuation allowance of $7.7 million, for a net deferred tax asset
of $1.4 million. Management expects that the Company will generate $4 million
of taxable income within the next 15 years to utilize the net deferred tax
asset. The taxable income will be generated through a combination of improved
operating results and tax planning strategies. Rather than lose the tax
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benefit, the Company could implement certain tax planning strategies including
the sale of the Company's catalog operations, since such operations generally
operate on a profitable basis. Alternatively, the Company could also sell its
catalog operation's mailing lists in order to generate income to enable the
Company to realize its NOL carryforwards. Based on the above operating
improvements combined with tax planning strategies in place, management believes
that adequate taxable income will be generated over the next 15 years in which
to utilize the NOL carryforwards.
Fiscal 1997 Compared With Transition Period
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Revenues for Fiscal 1997 were $38.5 million compared to $27.2 million for the
Transition Period ($41.2 million for the 52-week period ended February 1, 1997).
Retail net sales were $31.1 million in fiscal 1997 and $19.6 million in the
Transition Period ($26.8 million for the 52-week period ended February 1, 1997);
catalog net sales were $7.4 million in Fiscal 1997 and $7.6 million in the
Transition Period ($14.4 million for the 52-week period ended February 1, 1997).
Retail net sales declined 14% between Fiscal 1997 and the 52-week period ended
February 1, 1997, reflecting the partial year impact of three new stores opened
in early Fiscal 1997 and three new stores opened at the end of the year, offset
by same-store sales declines of 21%. The Company attributes its same-store
sales declines to the elimination of various marketing activities, promotional
offers and heavy couponing which enhanced sales but negatively impacted margins
and operating expenses.
The 49% decline in catalog net sales between Fiscal 1997 and the 52-week
period ended February 1, 1997 reflects the continued downsizing of the Company's
catalog circulation. Circulation was down 40% between Fiscal 1997 and the 52-
week period ended February 1, 1997. This reflects the Company's plan to reduce
the mailings of the catalog to operate it at a more profitable level.
Cost of goods sold represented 50% of net sales in Fiscal 1997 and 53% in the
Transition Period (54% in the 52-week period ended February 1, 1997). The
Company has achieved better gross margins in Fiscal 1997, continuing the
favorable trend in gross margin that began in the Transition Period. At the
same time, average inventory turns have increased from two times in the
Transition Period to three times in Fiscal 1997. This reflects the ongoing
effort to right size inventory levels and minimize the need for markdowns.
Operating expenses increased as a percentage of net sales to 50% or $19.2
million in Fiscal 1997 compared to 46% in the Transition Period or $12.6 million
($20.0 million or 48% of net sales in the 52-week period ended February 1,
1997). The remaining $13.3 million or 35% of sales and $9.7 million 36% of
sales, respectively ($16.2 million or 40% of sales in the 52-week period ended
February 1, 1997), are payroll and other operating expenses. These costs have
decreased as a percentage of sales, reflecting management's on-going attention
to cost reductions. The burden of fixed occupancy costs in light of the decline
in same-store sales had a negative impact on the Company's results for Fiscal
1997. This fact is a major part of the Company's decision to focus its retail
expansion plans on street locations, wherein occupancy and other fixed operating
costs are substantially lower than in mall locations.
General and administrative expenses were $3.9 million in Fiscal 1997 compared
to $2.9 million in the Transition Period ($4.5 million for the 52-week period
ended February 1, 1997). The Company experienced a 13% decline in general and
administrative expenses between Fiscal 1997 and the 52-week period ended
February 1, 1997. This decline reflects the impact of payroll and other
overhead cost reductions made in connection with the Company's efforts to reduce
expenses.
Pre-opening costs were $.7 million in Fiscal 1997 and $.5 million in the
Transition Period ($.7 million for the 52-week period ended February 1, 1997).
In Fiscal 1997, three stores were opened in the first half of the year (the
period through which the Company's policy of deferring pre-opening costs was in
effect) compared to twenty-one stores opened in the 52-week period ended
February 1, 1997. Due to the timing of the previous year's openings,
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the majority of the amortization related to these openings was recognized in
Fiscal 1997. The increased months' amortization offset by reductions in pre-
opening costs beginning in the Transition Period resulted in relatively flat
amortization expense for the comparable periods.
Depreciation and amortization expense increased to $1.6 million in Fiscal 1997
compared to $.8 million in the Transition Period ($1.2 million for the 52-week
period ended February 1, 1997). The increase results from a full-year impact of
the addition of build-outs and equipment for the new stores opened during the
Transition Period and the partial-year impact of stores opened during Fiscal
1997.
Other non-recurring expenses incurred in Fiscal 1997 include $1.3 million of
fixed assets and leasehold improvements written off in conjunction with planned
store closures, $.4 million in fixed assets and leasehold improvements written
off in conjunction with the Company's corporate office and distribution center
moves and $.2 million of severance expense.
Interest expense increased from $.2 million in the Transition Period and for
the 52-week period ended February 1, 1997 to $1.1 million in Fiscal 1997. This
reflects the interest charge on the Company's borrowings under its credit
facility and subordinated debt issuances which funded operating losses and
growth.
Transition Period Compared with Fiscal 1996
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Revenues for the Transition Period were $27.2 million compared to $26.5
million for the comparable period of Fiscal 1996. Catalog net sales for the
Transition Period were $7.6 million and were $16.6 million for the comparable
period of Fiscal 1996. The 54% decline in catalog net sales was a result of a
significant decrease in catalog circulation. The decrease in circulation
reflects management's efforts to discontinue the summer sale catalog which
generated very low margin sales and eliminate circulation to unprofitable
mailing lists.
Retail net sales were $19.6 million for the Transition Period compared to $9.9
million for the comparable period of Fiscal 1996. The increase in retail net
sales was a result of the Company's retail expansion; 37 stores were open at
February 1, 1997 as compared to 22 at June 1, 1996. Further, the Transition
Period includes the benefit of a full period's results for the eleven stores
opened in Fiscal 1996. Same-store sales were flat for the Transition Period.
Cost of goods sold represented 53% of net sales in the Transition Period and
54% of net sales in both Fiscal 1996 and the 33-week period ended February 3,
1996. The improvement in gross margin reflected the net positive impact of
steadily improved margins beginning in Fall 1996, offset by lower margins
generated at the beginning of the Transition Period due to heavy promotional
activity to improve the Company's inventory position. The margin improvement
was attributed to better management of inventory levels and the elimination of
excessive mark-down promotions.
Operating expense was $12.6 million, or 46% of net sales, in the Transition
Period compared to $18.3 million, or 45% of net sales, in Fiscal 1996. The
increase was primarily attributed to the addition of senior retail operations
management and increased telemarketing costs for the catalog.
General and administrative expense in the Transition Period was $2.9 million
compared to $4.3 million in Fiscal 1996 ($2.0 million in the 33-week period
ended February 3, 1996). The increase between the 33-week periods reflected the
investment made in executive and senior management in the merchandising areas to
support the Company's new retail stores and implement the Company's
merchandising strategy.
The Transition Period included $.5 million in pre-opening costs compared to
$.4 million in Fiscal 1996 ($265,000 in the 33-week period ended February 3,
1996). The increase resulted from the retail expansion over the
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previous two years. The Company amortized its new store opening costs over the
first twelve months of each store's operations.
Depreciation and amortization was $.8 million during the Transition Period as
compared to $.9 million in Fiscal 1996 ($.6 million in the 33-week period ended
February 3, 1996). The increase was due to the increase in property and
equipment resulting from the construction of new stores and installation of the
Company's new information system.
Non-recurring expenses of $.9 million incurred during the Transition Period
were primarily attributed to the following: the Company's former President
resigned in October 1996 resulting in a $.3 million severance charge; the
Company prepaid its line of credit upon funding of its new credit facility
resulting in $.1 million of prepayment charges; and the Company had taken action
to close two unprofitable retail store locations, which has resulted in a write-
off of $.4 million in non-recoverable assets.
The Company recognized $.2 million of income tax expense for the Transition
Period. This charge resulted from management's revaluation of the deferred tax
asset. In evaluating the deferred tax asset, management considered the
Company's plans and projections and available tax planning strategies.
Liquidity and Capital Resources
- -------------------------------
During Fiscal 1998, the Company's primary sources of liquidity were from
proceeds from the issuance of $3.85 million of non-interest bearing senior
subordinated notes and cash from operations. These sources financed the
Company's debt paydown and capital expenditures. Capital expenditures of
approximately $1.3 million were incurred in opening new store locations and
refurbishing several of the Company's older stores.
The Company has a $13.0 million credit facility (the "Credit Facility")
which consists of a $10.0 million revolving line of credit for working capital
(the "Revolving Line") and a $3.0 million capital expenditure facility (the
"Capex Line"). Availability under the Revolving Line is subject to a defined
borrowing base. As of January 30, 1999, no borrowings were outstanding under
the Revolving Line and $2.75 million was outstanding under the Capex Line; $3.05
million was available at January 30, 1999 under the Revolving Line. Interest
accrues on the Revolving Line at prime plus 1% and at prime plus 1.5% on the
Capex Line. At January 30, 1999 the bank's prime rate of interest was 7.75%.
The Credit Facility terminates on November 19, 1999, and on such date, all
borrowings thereunder are immediately due and payable. Borrowings under the
Credit Facility are secured by substantially all of the Company's assets. The
Company plans to replace the Credit Facility by November 1999, and believes that
it could extend the Credit Facility to May 2000.
The Credit Facility, as amended, requires the Company at all times to
maintain net worth (defined to include equity and subordinated debt) of at least
$8.0 million. The Credit Facility also limits the Company's earnings before
interest, taxes, depreciation and amortization (EBITDA) to the following loss
amounts: $900,000 for the twelve months ended January 31, 1999 and $500,000 for
the twelve months ending April 30, 1999. Minimum EBITDA of zero is required for
the twelve months ending July 31, 1999 and $400,000 for the twelve months ending
October 31, 1999. In addition, capital expenditures are limited to $1,750,000
in Fiscal 1999.
The Company's ability to fund its operations, open new stores and maintain
compliance with the Credit Facility is dependent on its ability to generate
sufficient cash flow from operations and secure financing beyond November 1999
as described above. Historically, the Company has incurred losses and may
continue to incur losses in the near term. Depending on the success of its
business strategy, the Company may continue to incur losses. Losses could
negatively affect working capital and the extension of credit by the Company's
suppliers and impact the Company's operations.
11
<PAGE>
In order to enhance the Company's liquidity and improve its capital
structure, the Company completed a private placement of non-interest bearing
senior subordinated notes in an aggregate principal amount of $3,850,000,
together with warrants to purchase an aggregate of 3,850,000 shares of common
stock exercisable at $2.00 per share. The new securities were sold for an
aggregate purchase price of $3,850,000 and were purchased principally by
affiliates of the Company. In connection with the sale of the new securities,
the Company entered into an agreement with all of the holders of the Company's
existing subordinated debt and warrant securities, representing an aggregate
principal amount of $6,000,000. Pursuant to the agreement, each holder agreed
to exchange all of its subordinated debt securities, together with any warrants
issued in connection therewith, for newly issued shares of preferred stock.
Holders of $3,000,000 principal amount existing subordinated debt securities
elected to receive Series A Preferred Stock which has no fixed dividend rights,
is not convertible into common stock and is mandatorily redeemable by the
Company in May 2002. Holders of $3,000,000 principal amount subordinated debt
securities elected to receive Series B convertible preferred stock which has no
fixed dividend rights, is convertible into common stock at a price per share of
$3.00 and is not mandatorily redeemable by the Company. Holders of the
$3,850,000 principal amount of new subordinated debt securities elected to
receive Series C convertible preferred stock which has no fixed dividend rights,
is convertible into common stock at a price per share of $2.00 and is not
mandatorily redeemable by the Company. The issuance of the shares of preferred
stock upon exchange of the subordinated debt securities was approved by the
Company's shareholders at its annual meeting of shareholders on December 15,
1998.
In the restructuring described above, the holders of $6.0 million principal
amount of subordinated debt permanently waived their rights to receive interest
payments and agreed to exchange such debt for preferred stock, resulting in the
Company's elimination of approximately $.6 million in annual interest payments.
In addition, the proceeds from the Company's private placement of $3,850,000
were used to pay off the Company's revolving line of credit.
Impact of Inflation
- -------------------
The impact of inflation on results of operations has not been significant
during the Company's last three fiscal years.
Seasonality
- -----------
The Company's business is not as significantly impacted by seasonal
fluctuations, when compared to many other specialty retail and catalog
operations. The Right Start's products are for the most part need-driven and the
customer is often the end user of the product. However, the Company does
experience increased sales during the Christmas holiday season.
Other Matters
- -------------
Year 2000
- ---------
The year 2000 problem is the result of computer programs being written using
two digits (rather than four) to define the applicable year. Any of the
Company's programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000 which could result in
miscalculations or system failures.
The Company is currently working to identify and resolve all potential issues
relating to the year 2000 on the processing of date-sensitive information by the
Company's computerized information system. For purposes
12
<PAGE>
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>
<CAPTION>
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 x
Accounting and Reporting x x x x
Point of Sale Transactions x x
Non-computerized systems (none x x
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.
The Company is currently working with its software vendors for inventory
maintenance systems and accounting and reporting systems to complete the
installation of the upgraded, year 2000 compliant version of these systems. The
Company is working with its vendor for its point of sale ("POS") system to
complete the program changes required for this system to be year 2000 compliant.
If, in a worst-case scenario, the necessary upgrades could not be completed in a
timely manner, the Company's contingency plans provide for the purchase and
installation of replacement POS software. No other systems are material to the
Company's operations.
New Accounting Requirements
- ---------------------------
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5 "Reporting on the Costs of Start-up Activities" (SOP
98-5) which requires that the costs of start-up activities and organization
costs be expensed as incurred. The statement is effective for the Company in
Fiscal 2000 and the impact of the adoption of SOP 98-5 is not expected to be
material to the Company's financial position or results of operations.
Effective October 1, 1997 and as disclosed in Note 1, the Company began
expensing all store pre-opening costs as incurred.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------- ----------------------------------------------------------
In the ordinary course of operations, the Company faces no significant market
risk. Its purchase of imported products subjects the Company to a minimum
amount of foreign currency risk. Foreign currency risk is that risk associated
with recurring transactions with foreign companies, such as purchases of goods
from foreign vendors. If the strength of foreign currencies increases compared
to the U.S. dollar, the price of imported products could increase. However, the
Company has no commitments for future purchases with foreign vendors and,
additionally, the Company has the ability to source products domestically in the
event of import price increases.
See "Management's Discussion and Analysis of Financial condition and Results
of Operations -- Liquidity and Capital Resources" above for a discussion of
debt obligations of the Company, the interest rates of which are linked to the
prime rate. The Company has not entered into any derivative financial
instruments to mange interest rate risk, currency risk or for speculative
purposes and is currently not evaluating the future use of such instruments.
13
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ------- -------------------------------------------
The financial statements and supplementary data of the Company are as set
forth in Item 14(a) hereof.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------- ---------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
The Company has not had any changes in or disagreements with its accountants
on the Company's accounting and financial disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -------- --------------------------------------------------
DIRECTORS
<TABLE>
<CAPTION>
Name Age Director Business Experience
---- --- --------- -------------------
Since
-----
<S> <C> <C> <C>
Andrew Feshbach 38 1995 Mr. Feshbach is a Vice President of Fortune Financial,
President of Big Dog Sportswear and an Executive Vice
President of Fortune Fashions. Previously, Mr.
Feshbach was a partner in Maiden Lane, a merchant
bank, and a Vice President in the Mergers and
Acquisitions Group of Bear Stearns & Co. Inc.
Robert R. Hollman 55 1995 Mr. Hollman has been President and Chief Executive
Officer of Topa Management Company since 1971 and
President and Chief Executive Officer of Topa Savings
Bank since 1989. He has also been a Director and
Officer of Topa Equities, Ltd., the parent company of
Topa Savings Bank, since 1969.
Fred Kayne 61 1995 Mr. Kayne is President and Chairman of Fortune
Financial, where he is responsible for directing all
of its investment activities. Mr. Kayne is also
President of Fortune Fashions and Chairman of Big Dog
Sportswear. Mr. Kayne was a partner of Bear, Stearns
& Co. Inc. until its initial public offering in 1985
after which he was a Managing Director and a member of
the Board of Directors until he resigned in 1986.
Fred Kayne and Richard A. Kayne are brothers.
</TABLE>
14
<PAGE>
<TABLE>
<S> <C> <C> <C>
Richard A. Kayne 54 1995 Mr. Kayne currently serves as President and Chief
Executive Officer of Kayne Anderson Investment
Management, Inc., and its broker dealer affiliate,
K.A. Associates, Inc. Mr. Kayne has been with Kayne
Anderson Investment Management, Inc. since 1985 when
it was founded by Mr. Kayne and John E. Anderson. He
is also a Director of Foremost Corporation of America
and Glacier Water Services, Inc. Richard A. Kayne and
Fred Kayne are brothers.
Jerry R. Welch 48 1995 See "Business Experience of Executive Officers" above.
Howard M. Zelikow 65 1995 Mr. Zelikow has been a management and financial
consultant doing business at ZKA Associates since 1987
and has been a Managing Director of Kayne Anderson
Investment Management, Inc. since 1988. Mr. Zelikow
has been a director of Financial Security Assurance
Holdings Ltd. since 1996 and has served as a director
of Queensway Financial Holdings Limited since 1993.
Mr. Zelikow was a director of Victoria Financial
Corporation from 1991 to 1995, a director of Capital
Guaranty Corporation from 1994 to 1995, and a director
of Nobel Insurance Limited from 1989 to 1993.
</TABLE>
The Directors of the Company serve until their successors are elected and duly
qualified at next year's Annual Meeting of Shareholders, which is expected to be
held on or about June 2000. During the fiscal year ended January 30, 1999, the
Company's Audit Committee consisted of Messrs. Feshbach, Hollman and Zelikow and
the Company's Compensation Committee consisted of Messrs. Richard Kayne and Fred
Kayne. The Board of Directors does not have a standing Nominating Committee.
The Audit Committee reviews and reports to the Board of Directors with respect
to various auditing and accounting matters, including the selection of the
Company's independent accountants. The Compensation Committee reviews the
Company's general compensation strategy and reviews and reports to the Board of
Directors with respect to compensation of officers and employee benefit
programs.
EXECUTIVE OFFICERS
The executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Executive
Name Age Position Officer Since
---- --- -------- -------------
<S> <C> <C> <C>
Jerry R. Welch 48 Chairman of the Board, 1996
President and Chief
Executive Officer
Gina M. Engelhard 35 Chief Financial Officer and 1994
Secretary
Ronald J. Blumenthal 53 Senior Vice President 1994
</TABLE>
15
<PAGE>
<TABLE>
<S> <C> <C> <C>
Gerald E. Mitchell 44 Senior Vice President-Merchandising 1996
and Marketing
Marilyn Platfoot 44 Senior Vice President-Retail 1996
Operations and Human Resources
Richard Pollock 44 Vice President-Logistics 1996
</TABLE>
All officers serve at the discretion of the Board of Directors.
Business Experience of Executive Officers
JERRY R. WELCH became Chief Executive Officer of the Company in March 1996,
assumed the position of President in September 1996 and has served as Chairman
of the Board since August 1995. Mr. Welch also serves as a Managing Director of
Kayne Anderson Investment Management, Inc. and has served in such capacity since
January 1993. Mr. Welch is also the Chairman of the Board and Chief Executive
Officer of Glacier Water Services, Inc. and has served in such capacities since
April 1993 and September 1994, respectively.
GINA M. ENGELHARD became Chief Financial Officer of the Company in May 1994
and Secretary in August 1995. Ms. Engelhard served as a Senior Manager with
Price Waterhouse in Woodland Hills, California from January 1986 until April
1994.
RONALD J. BLUMENTHAL became Senior Vice President of the Company in September
1996 and served as Vice President-Retail Operations from December 1993 to
September 1996. Prior to joining the Company, Mr. Blumenthal served as Vice
President of Store Operations for Cost Plus Imports from 1990 until 1993.
GERALD E. MITCHELL became Senior Vice President-Merchandising and Marketing in
May 1999. Prior to that, Mr. Mitchell served as Vice President-Merchandising of
the Company from July 1996 to April 1999. Prior to joining the Company, Mr.
Mitchell served as Vice President-Merchandising for Discovery Channel Stores.
Mr. Mitchell's prior experience includes senior management roles in department
store merchandising and product management.
MARILYN PLATFOOT became Senior Vice President-Retail Operations and Human
Resources in May 1999. Prior to that, Ms. Platfoot served as Vice President-
Retail Operations of the Company from April 1996 to April 1999. Ms. Platfoot
previously served as Western Regional Manager for Brookstone Stores from 1992 to
1996.
RICHARD POLLOCK became Vice President-Logistics of the Company in September
1996 and served as Director of Logistics from June to September 1996. Prior to
joining the Company, Mr. Pollock served as Regional Operations Manager with USCO
Distribution Services and has held several senior level distribution positions.
COMPLIANCE WITH SECTION 16(a) OF
THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's executive officers, directors and persons
who own more than 10% of the Company's common stock to file reports of ownership
on Forms 3, 4 and 5 with the Commission. Executive officers, directors and 10%
16
<PAGE>
stockholders are required by the Commission to furnish the Company with copies
of all Forms 3, 4 and 5 as filed.
Based solely on the Company's review of the copies of such forms it has
received, the Company believes that all of its executive officers, directors and
greater than 10% beneficial owners complied with all the filing requirements
applicable to them with respect to transactions during the fiscal year ended
January 30, 1999.
ITEM 11. EXECUTIVE COMPENSATION
- -------- ----------------------
Executive Compensation
The following table sets forth summary information concerning compensation
paid or accrued by the Company for services rendered during the fiscal year
ended January 30, 1999, the fiscal year ended January 31, 1998 and the
transition period ended February 1, 1997 to the Company's Chief Executive
Officer and the other executive officers who received compensation (on an
annualized basis) of at least $100,000.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation
------------------- Long Term
---------
Compensation
------------
Fiscal Other Annual Securities Underlying
Name and Principal Position Year Salary Bonus Compensation (1) Options (#)
- --------------------------- ------ -------- --------- ---------------- -----------
<S> <C> <C> <C> <C> <C>
Jerry R. Welch (2) 1998 $ -0- $ -0- $ -0- 211,669
Chairman of the Board, 1997 -0- -0- -0- 7,383
President and Chief Transition -0- -0- -0- 4,609
Executive Officer Period
Ronald J. Blumenthal 1998 135,000 -0- -0- 62,500
Senior Vice President 1997 135,000 -0- -0- 7,500
Transition 90,865 -0- -0- -0-
Period
Gerald E. Mitchell 1998 164,046 -0- 4,477 77,500
Vice President - Merchandising 1997 155,000 -0- 8,048 7,500
Transition 80,481 -0- 3,875 37,500
Period
Marilyn Platfoot 1998 137,615 -0- 62 77,500
Vice President Retail 1997 115,000 -0- -0- 7,500
Operations Transition 72,981 -0- -0- -0-
Period
Gina M. Engelhard 1998 113,292 -0- -0- 60,000
Chief Financial Officer and 1997 105,000 -0- -0- 5,000
Secretary Transition 66,635 -0- 750 -0-
Period
</TABLE>
17
<PAGE>
(1) Amounts shown include Company contributions under the Company's Employee
Stock Ownership Plan and the Company's Employee Stock Purchase Plan, as
applicable for the listed executives.
(2) Mr. Welch receives no compensation for serving as Chief Executive Officer
or President.
Directors' Fees
All of the Company's non-employee directors receive directors' fees of $3,000
per quarter. All of the members of the Board of Directors have elected, in lieu
of such compensation, to receive options to purchase common stock of the Company
at the fair market value on the date the options are granted.
Option Grants in the Fiscal Year Ended January 30, 1999
The following table provides certain information regarding stock options
granted to the Named Executive Officers during the fiscal year ended January 30,
1999.
<TABLE>
<CAPTION>
Individual Grants
-----------------
Number of
Common Shares % of Total Potential Realizable Value at
Underlying Options Assumed Annual Rates of
Options Granted to Stock Price Appreciation for
Granted Employees Exercise or Option Term
------- in Fiscal Base Price Expiration -----------
(#)(1) Year ($/Share) Date
------ ---- --------- ----
Name 5%($) 10%($)
- ---- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Jerry R. Welch 10,169 1.40% $2.50 12/15/01 4,068 8,847
1,500 0.21 2.50 12/15/08 2,430 6,405
200,000 27.52 2.50 12/15/08 324,000 854,000
Gerald Mitchell 62,500 8.60 3.50 05/05/08 141,875 373,750
15,000 2.06 2.50 12/15/08 24,300 64,050
Ron Blumenthal 37,500 5.16 3.50 05/05/08 85,125 224,250
25,000 3.44 2.50 12/15/08 40,500 106,750
Marilyn Platfoot 62,500 8.60 3.50 05/05/08 141,875 373,750
15,000 2.06 2.50 12/15/08 24,300 64,050
Gina Engelhard 50,000 6.88 3.50 05/05/08 113,500 299,000
10,000 1.38 2.50 12/15/08 16,200 42,700
</TABLE>
___________________
(1) Named Executive Officers receive options pursuant to the Company's stock
compensation plans described elsewhere in this Proxy Statement. The material
terms of that program related to recipients, grant timing, number of options,
option price and duration are determined by the Board of Directors, subject to
certain limitations.
18
<PAGE>
Aggregate Option Exercises in the Fiscal Year Ended January 30, 1999 and Option
Values at Fiscal Year End
The following table provides certain information regarding the exercise of
stock options held by the Named Executive Officers during the fiscal year ended
January 30, 1999 and the number and value of options held as of the end of such
fiscal year.
<TABLE>
<CAPTION>
Number of Securities Underlying Value of Unexercised
Unexercised Options At In-The-Money Options
Fiscal Year End (#) At Fiscal Year End ($)(1)
---------------------- -------------------------
Shares Aquired Value
Name on Exercise (#) Realized($)(1) Exercisable Unexercisable Exercisable Unexercisable
- ------------------- -------------------- ----------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Jerry R. Welch -0- -0- 17,151 211,669 7,383 740,842
Ronald J. Blumenthal -0- -0- -0- 62,500 -0- 181,250
Gerald E. Mitchell -0- -0- -0- 77,500 -0- 280,750
Marilyn Platfoot -0- -0- -0- 77,500 -0- 280,750
Gina M. Engelhard -0- -0- -0- 60,000 -0- 160,000
</TABLE>
_________________________
(1) On January 29, 1999 (the last day the Company's common stock was traded in
the fiscal year ended January 30, 1999), the closing sale price of the
Company's common stock on the Nasdaq National Market System was $6.00 per
share.
Employment Agreements
No employment agreements are currently in effect between the Company and any
of its employees.
Stock Compensation Programs
1991 Employee Stock Option Plan
The Company adopted the 1991 Plan, as amended, to cover an aggregate of
725,000 shares of the Company's common stock, in October 1991, in order to
provide a means of encouraging certain officers and employees of the Company to
obtain a proprietary interest in the enterprise and thereby create an additional
incentive for such persons to further the Company's growth and development. The
information regarding the 1991 Plan provided herein is qualified in its entirety
by the full text of such plan, copies of which have been filed with the
Securities and Exchange Commission. Options granted vest over periods of up to
five years (depending on the terms of the individual grant) commencing on the
grant date and expire 10 years thereafter. Options for 696,160 shares were
outstanding as of January 30, 1999 under the 1991 Plan, 11,991 of which were
exercisable.
1995 Non-Employee Directors Option Plan
In October 1995, the Company adopted the 1995 Plan, as amended, to cover an
aggregate of 175,000 shares of common stock. The information regarding the 1995
Plan provided herein is qualified in its entirety by the full text of such plan,
copies of which have been filed with the Securities and Exchange Commission.
The 1995 Plan provides for the annual issuance, to each non-employee director,
of options to purchase 1,500 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
19
<PAGE>
termination of Board membership. 153,859 options were issued under the 1995
Plan, 95,515 of which were exercisable as of January 30, 1999.
Company Employee Stock Purchase Plan
The Company matches employees' contributions to the Company Employee Stock
Purchase Plan at a rate of 50%. The Company's contributions amounted to
$14,000, $24,000, $21,000 and $28,000 in Fiscal 1998, Fiscal 1997, the
Transition Period ended February 1, 1997 and Fiscal 1996.
Company Employee Stock Ownership Plan
The Company Employee Stock Ownership Plan is funded exclusively by
discretionary contributions determined by the Board of Directors. No
contributions were authorized for Fiscal 1998, Fiscal 1997 or the Transition
Period ended February 1, 1997. The Board of Directors authorized contributions
of $70,000 to the Company Employee Stock Ownership Plan in Fiscal 1996.
Compensation Committees Interlocks and Insider Participation
Richard Kayne and Fred Kayne, each directors of the Company, are each
members of the Company's Compensation Committee and have participated in
transactions requiring disclosure under the section "Certain Relationships and
Related Transactions."
20
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -------- --------------------------------------------------------------
The following table sets forth certain information, as of May 21, 1999, with
respect to all those known by the Company to be the beneficial owners of more
than 5% of its outstanding common stock, each director who owns shares of common
stock, each executive officer named in the Summary Compensation Table (the
"Named Executive Officers"), and all directors and executive officers of the
Company as a group.
<TABLE>
<CAPTION>
Name and Address of Beneficial Amount and Nature of Percent of
- ------------------------------ Beneficial ----------
Owner Ownership(1) Class
- ----- ------------ -----
<S> <C> <C>
Richard A. Kayne (2) $4,362,227 60.9%
KAIM Non-Traditional, L.P.
1800 Avenue of the Stars
Second Floor
Los Angeles, CA 90067
Cahill, Warnock Strategic Partners 373,333 6.9%
Fund, L.P. (3)
One South Street, Suite 2150
Baltimore, MD 21202
Fred Kayne (4) 703,172 13.2%
Fortune Fashions
6501 Flotilla Street
Commerce, CA 90040
Albert O. Nicholas 312,500 6.2%
Nicholas Co., Inc.
700 North Water Street
Milwaukee, WI 53202
Howard Kaplan 305,000 6.0%
99 Chauncy Street
Boston, MA 02111
Lloyd I. Miller, III (5) 256,900 5.1%
4550 Gordon Drive
Naples, Florida 34102
Citigroup Inc. (6) 316,600 6.2%
153 East 53rd Street
New York, NY 10043
Gerald E. Mitchell (7) 42,143 *
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
Gina M. Engelhard (8) 20,716 *
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
Marilyn Platfoot (9) 27,606 *
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Andrew Feshbach (10) 17,151 *
Big Dog Sportswear
121 Gray Avenue, Suite 300
Santa Barbara, CA 93101
Robert R. Hollman (10) 9,768 *
Topa Management
1800 Avenue of the Stars
Suite 1400
Los Angeles, CA 90067
Jerry R. Welch (10)(11) 217,151 4.1%
Kayne Anderson Investment
Management, Inc.
1800 Avenue of the Stars
Second Floor
Los Angeles, CA 90067
Howard M. Zelikow (10)(11) 17,151 *
Kayne Anderson Investment
Management, Inc.
1800 Avenue of the Stars
Second Floor
Los Angeles, CA 90067
Ronald J. Blumenthal (12) 33,296 *
5388 Sterling Center Drive, Unit C
Westlake Village, CA 91361
All executive officers and directors 5,474,030 69.9%
as a group (eleven persons) (13)
</TABLE>
_________________________
* Less than one percent.
(1) Except as otherwise noted below, the persons named in the table have
sole voting power and investment power with respect to all shares of
common stock shown as beneficially owned by them, subject to community
property laws where applicable.
(2) The 4,362,227 shares include (i) 87,367 shares held directly by Mr.
Kayne (including 17,151 shares which may be acquired within 60 days
upon exercise of options) and (ii) 4,274,860 shares held by managed
accounts of KAIM Non-Traditional, L.P. ("KAIM, LP"), a registered
investment adviser (including 399,999 shares which may be acquired
upon conversion of the Series B Preferred Stock and 1,691,650 shares
which may be acquired upon conversion of the Series C Preferred
Stock). Mr. Kayne has sole voting and dispositive power over the
shares he holds directly. He has shared voting and dispositive power
along with Kayne Anderson Investment Management, Inc. ("KAIM, Inc."),
the general partner of KAIM, LP, over the remaining shares. (Mr.
Kayne is the President, Chief Executive Officer and a Director or
KAIM, Inc., and the principal stockholder of its parent company.) The
shares held by managed accounts of KAIM, LP include the following
shares held by investment funds for which KAIM, LP serves as general
partner or manager: 1,256,051 shares held by Kayne Anderson Non-
Traditional
22
<PAGE>
Investments, L.P. (including 50,000 shares which may be acquired upon
conversion of the Series B Preferred Stock and 465,200 shares which
may be acquired upon conversion of the Series C Preferred Stock);
1,056,025 shares held by ARBCO Associates, L.P. (including 50,000
shares which may be acquired upon conversion of the Series B Preferred
Stock and 465,200 shares which may be acquired upon conversion of the
Series C Preferred Stock); 1,117,612 shares held by Offense Group
Associates, L.P. (including 133,333 shares which may be acquired upon
conversion of the Series B Preferred Stock and 465,200 shares which
may be acquired upon conversion of the Series C Preferred Stock);
478,822 shares held by Opportunity Associates, L.P. (including 91,666
shares which may be acquired upon conversion of the Series B Preferred
Stock and 211,450 shares which may be acquired upon conversion of the
Series C Preferred Stock); and 197,100 shares held by Kayne Anderson
Offshore Limited (including 75,000 shares which may be acquired upon
conversion of the Series B Preferred Stock and 84,600 shares which may
be acquired upon conversion of the Series C Preferred Stock). KAIM
disclaims beneficial ownership of the shares reported, except those
shares attributable to it by virtue of its general partner interests
in the limited partnerships holding such shares. Mr. Kayne disclaims
beneficial ownership of the shares reported, except those shares held
by him directly or attributable to him by virtue of his limited and
general partner interests in such limited partnerships and by virtue
of his indirect interest in the interest of KAIM in such limited
partnerships. The foregoing is based on information provided by Mr.
Kayne and KAIM, L.P. to the Company as of May 21, 1999.
(3) David L. Warnock and Edward L. Cahill are each managing members of
Cahill, Warnock & Company, LLC ("CW") and general partners of Cahill,
Warnock Strategic Partners, L.P. ("CWSP"). CWSP and CW are the
general partners, respectively, of Cahill, Warnock Strategic Partners
Fund, L.P. ("SPF") and Strategic Associates, L.P. ("SA"). SPF owns
9,475 shares of Series B Preferred Stock currently convertible into
315,833 shares of common stock. SA owns 525 shares of Series B
Preferred Stock currently convertible into 17,500 shares of common
stock. Each of Messrs. Warnock and Cahill, CW, CWSP, SPF and SA may
be deemed to beneficially own 373,333 shares of common stock. Messrs.
Warnock and Cahill, CW and CWSP disclaim beneficial ownership with
respect to the shares held by SPF and SA. SPF disclaims beneficial
ownership with respect to the shares underlying the Series B Preferred
Stock held by SA. SA disclaims beneficial ownership with respect to
the shares underlying the Series B Preferred Stock held by SPF. The
shares reported above and in the table exclude 4,608 currently
exercisable options to purchase common stock held by Mr. Warnock.
(4) Of the 703,172 shares beneficially owned, 427,688 shares are held
directly by Mr. Kayne, 83,333 shares may be acquired upon conversion
of Series B Preferred Stock, 175,000 shares may be acquired upon
conversion of Series C Preferred Stock and 17,151 are underlying
currently exercisable options to purchase common stock.
(5) According to a Schedule 13G filed on February 1, 1999, Mr. Miller
shares dispositive and voting power on 139,250 shares of the reported
securities as an adviser to the trustee of certain family trusts and
Mr. Miller has sole voting and dispositive power on 117,650 of the
reported securities owned by him personally and/or as the manager of a
limited liability company that is the general partner of a limited
partnership.
(6) Includes 250,000 shares of common shares held directly by Primerica
Life Insurance Company and 66,600 shares of common stock which may be
acquired upon conversion of the Series B Preferred Stock.
(7) Includes 4,500 shares, currently exercisable options to purchase
27,500 shares of common stock and 10,102 and 42 shares held by the
Company's Employee Stock Purchase Plan and Employee
23
<PAGE>
Stock Ownership Plan, respectively for the benefit of Mr. Mitchell.
(8) Includes 145 shares, currently exercisable options to purchase 20,000
shares of common stock and 571 shares held by the Company's Employee
Stock Ownership Plan for the benefit of Ms. Engelhard.
(9) Includes currently exercisable options to purchase 27,500 shares of
common stock and 75 and 31 shares held by the Company's Employee Stock
Purchase Plan and Employee Stock Ownership Plan, respectively, for the
benefit of Ms. Platfoot.
(10) All shares consist of currently exercisable options to purchase common
stock.
(11) Messrs. Welch and Zelikow are Managing Directors of Kayne Anderson
Investment Management, Inc.; however, they disclaim beneficial
ownership with respect to shares held by KAIM or any of its
affiliates.
(12) Includes currently exercisable stock options to purchase 32,500 shares
of common stock and 796 shares held by the Company's Employee Stock
Ownership Plan for the benefit of Mr. Blumenthal.
(13) Includes options and common stock beneficially owned by executive
officers and directors, including 23,649 with respect to Mr. Pollock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- -------- ----------------------------------------------
CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS
During the fiscal year ended January 30, 1999, Kayne Anderson Investment
Management, Inc. provided management, consulting and advisory services to the
Company for which it received a fee of $100,000.
In April 1998, each of the holders, including SPF ($3,790,000), SA ($210,000),
Fred Kayne ($250,000), KAIM ($1,200,000) and Citigroup Inc. ($200,000), (a) of
the Company's Convertible Debentures dated October 11, 1996, as amended on May
30, 1997, in the aggregate principal amount of $3,000,000 (the "1996
Debentures") and (b) of the Company's 11.5% Senior Subordinated Notes due May 6,
2000 in the aggregate principal amount of $3,000,000 (the "'1997 Notes") and
warrants to purchase 237,500 shares of the Company's common stock issued in
connection with the 1997 Notes (the "1997 Warrants" and together with the 1997
Notes, the "1997 Securities") entered into a Letter Agreement dated April 6,
1998, as amended on April 13, 1998 and July 7, 1998 (collectively, the "Amended
Letter Agreement") setting forth a plan of recapitalization (the
"Recapitalization").
The Recapitalization consisted of the following: (a) the issuance of
$3,850,000 aggregate principal amount of the Company's non-interest bearing
Senior Subordinated Notes due May 6, 2000 (the "New Notes") and detachable
warrants to purchase 1,925,000 shares of the Company's common stock (the "New
Warrants", and together with the New Notes, the "1998 New Securities") to, among
others, Fred Kayne ($350,000) and KAIM ($3,383,333), (b) a waiver by the holders
of all of their rights to interest payments accrued and owing on the 1996
Debentures and the 1997 Notes on or after February 28, 1998, (c) an agreement by
the holders to exchange the 1996 Debentures and the 1997 Securities for either
Series A Mandatorily Redeemable Preferred Stock or Series B Convertible
Preferred Stock and (d) an agreement by the holders to exchange the 1998 New
Securities for Series C Convertible Preferred Stock simultaneous with the
exchange of the 1996 Debentures and the 1997 Securities for Series A Mandatorily
Redeemable Preferred Stock and/or Series B Convertible Preferred
24
<PAGE>
Stock.
On December 28, 1998, as part of the Recapitalization, (a) each of the
holders of the 1996 Debentures and the 1997 Securities exchanged such securities
for Series A Mandatorily Redeemable Preferred Stock and Series B Convertible
Preferred Stock, as detailed below for certain affiliates of the Company:
<TABLE>
<CAPTION>
Aggregate principal amount of Series A Mandatorily
1996 Debentures and Redeemable Series B Convertible
1997 Securities Preferred Stock Preferred Stock
-------------------------- ------------------- --------------------
<S> <C> <C> <C>
SPF $3,790,000 28,425 shares 9,475 shares
SA 210,000 1,575 525
Fred Kayne 250,000 0 2,500
KAIM 1,200,000 0 12,000
Citigroup 200,000 0 2,000
</TABLE>
and (b) each of the holders of the 1998 Securities exchanged such securities for
Series C Convertible Preferred Stock, as detailed below for certain affiliates
of the Company:
<TABLE>
<CAPTION>
Aggregate principal amount of Series C Convertible
1996 Debentures and 1997 Securities Preferred Stock
----------------------------------- ---------------
<S> <C> <C>
Fred Kayne $ 250,000 2,500 shares
KAIM 1,200,000 12,000
</TABLE>
25
<PAGE>
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.
<TABLE>
<CAPTION>
(1) Financial Statements: Page
----
<S> <C>
Report of Independent Accountants F - 1
Balance Sheet January 30, 1999 and January 31, 1998 F - 2
Statement of Operations Periods Ended January 30, 1999, F - 3
January 31, 1998, February 1, 1997 and June 1, 1996
Statement of Changes in Shareholders' Equity Periods Ended January 30, F - 4
1999, January 31, 1998, February 1, 1997 and June 1, 1996
Statement of Cash Flows Periods Ended January 30, 1999, January 31, 1998, F - 5
February 1, 1997 and June 1, 1996
Notes to Financial Statements F - 6
(2) Financial Statement Schedules:
Valuation Reserves F - 21
</TABLE>
All other financial statement schedules are omitted because they are
either not applicable or the required information is shown in the
financial statements or notes thereto.
(3) Listing of Exhibits
The following exhibits are filed as part of, or incorporated by
reference into, this annual report:
26
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number
- ------
<C> <S>
3.1 Amended and Restated Articles of Incorporation of the Company, dated August 12, 1991(1)
3.1.1 Amendment to Articles of Incorporation, dated August 20, 1991(1)
3.1.2 Form of Amendment to Articles of Incorporation, dated August 24, 1991(1)
3.2 Bylaws of the Company, as amended(2)
3.3 Specimen Certificate of the Common Stock (without par value)(1)
10.1 1991 Key Employee Stock Option Plan(3)
10.2 Form of Indemnification Agreement between Registrant and its directors and executive officers(3)
10.3 Asset Purchase Agreement for Acquisition of the Assets of Small People, Inc. and Jimash
Corporation by Right Start Subsidiary I, Inc.(4)
10.4 1995 Non-employee Directors Option Plan(5)
10.5 Registration Rights Agreement dated August 3, 1995 between Registrant and Kayne Anderson
Non-Traditional Investments LP, ARBCO Associates LP, Offense Group Associates LP, Opportunity
Associates LP, Fred Kayne, Albert O. Nicholas and Primerica Life Insurance Company(5)
10.6 Asset Purchase Agreement dated as of July 29, 1996 by and between Blasiar, Inc. (DBA Alert
Communications Company) and The Right Start, Inc.(5)
10.7 Convertible Debenture Purchase Agreement between The Right Start, Inc. and Cahill Warnock
Strategic Partners, LP dated as of October 11, 1996(6)
10.7.1 First Amendment to Convertible Debenture Purchase Agreement between The Right Start, Inc. and
Cahill Warnock Strategic Partners, LP dated as of May 30, 1997(11)
10.8 Convertible Debenture Purchase Agreement between The Right Start, Inc. and Strategic
Associates, LP dated as of October 11, 1996(6)
10.8.1 First Amendment to Convertible Debenture Purchase Agreement between The Right Start, Inc. and
Strategic Associates, LP dated as of May 30, 1997(11)
10.9 Registration Rights Agreement dated October 11, 1996 between The Right Start, Inc. and
Strategic Associates, L.P.(7)
10.10 Registration Rights Agreement dated October 11, 1996 between The Right Start, Inc. and Cahill,
Warnock Strategic Partners Fund, L.P.(7)
10.11 Loan and Security Agreement dated as of November 14, 1996 between The Right Start, Inc. and
Heller Financial, Inc.(6)
10.12 First Amendment to Loan and Security Agreement and Limited Waiver and Consent(8)
10.13 Second Amendment to Loan and Security Agreement and Limited Waiver and Consent(9)
10.14 Third Amendment to Loan and Security Agreement and Limited Waiver and Consent(9)
</TABLE>
27
<PAGE>
<TABLE>
<S> <C>
10.15 Fourth Amendment to Loan and Security Agreement and Limited Waiver and Consent(7)
10.16 Registration Rights Agreement dated May 6, 1997 between The Right Start, Inc. and certain Kayne
Anderson funds, Cahill, Warnock Strategic Partners Fund, L.P., Strategic Associates, L.P., The
Travelers Indemnity Company and certain other investors named therein(7)
10.17 Registration Rights Agreement dated September 4, 1997 between The Right Start, Inc. and certain
Kayne Anderson funds, Cahill, Warnock Strategic Partners Fund, L.P., The Travelers Indemnity
Company and certain other investors named therein(7)
10.18 The Right Start, Inc. Letter Agreement dated as of April 6, 1998(10)
10.19 The Right Start, Inc. Amendment to Letter Agreement dated as of April 13, 1998(10)
10.20 The Right Start, Inc. Securities Purchase Agreement dated as of May 6, 1997 between the Company
and certain investors listed therein with respect to the Company's 11.5% Senior Subordinated
Notes due May 6, 2000 and warrants to purchase the Company's common stock(10)
10.21 The Right Start, Inc. Securities Purchase Agreement dated as of April 13, 1998 between the
Company and certain investors listed therein with respect to the Company's Senior Subordinated
Notes due May 6, 2000 and warrants to purchase the Company's common stock(10)
10.22 Registration Rights Agreement dated April 13, 1998 between The Right Start, Inc. and the
investors named therein(7)
10.23 The Right Start, Inc. Securities Purchase Agreement dated as of September 4, 1997 between the
Company and the investors named therein with respect to 1,510,000 shares of the Company's
common stock(9)
23.1 Consent of Independent Accountants
27.1 Financial Data Schedule (13)
</TABLE>
__________________________
(1) Previously filed as an Exhibit to the Company's Registration Statement of
Form S-1 dated August 29, 1991.
(2) Previously filed as an Exhibit to Amendment Number 2 to the Company's
Registration Statement on Form S-1 dated October 3, 1991.
(3) Previously filed as an Exhibit to Amendment Number 1 to the Company's
Registration Statement on Form S-1 dated September 11, 1991.
(4) Previously filed as an Exhibit to the Company's 10-K for the fiscal year
ended May 26, 1993.
(5) Previously filed as an Exhibit to the Company's 10-K for the year ended
June 1, 1996.
(6) Previously filed as an Exhibit to the Company's 10-Q for the period ended
November 30, 1996.
(7) Previously filed as an Exhibit to the Company's 10-K for the fiscal year
ended January 31, 1998, as amended.
(8) Previously filed as an Exhibit to the Company's 10-K for the transition
period from June 2, 1996 to February 1, 1997.
(9) Previously filed as an Exhibit to the Company's 10-Q for the period ended
August 2, 1997.
28
<PAGE>
(10) Previously filed as an Exhibit to the Company's 8-K dated April 23, 1998.
(11) Previously filed as an Exhibit to the Company's 10-Q for the period ended
May 3, 1997.
(12) Previously filed as an Exhibit to the Company's 8-K dated May 6, 1997.
(13) Previously filed as an Exhibit to the Company's 10-K for the fiscal year
ended January 30, 1999 as filed on April 30, 1999.
(b) Reports on Form 8-K
A Report on Form 8-K was filed by the Company on January 25, 1999. There
were no other Reports on Form 8-K filed by the Company during the last
quarter of Fiscal 1998.
(c) A list of exhibits included as part of this report is set forth in Part IV
of this Annual Report on Form 10-K above and is hereby incorporated by
reference herein.
(d) Not applicable
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
THE RIGHT START, INC.
(Registrant)
Dated: May 27, 1999 /s/ Gina M. Engelhard
---------------------------------
Gina M. Engelhard
Chief Financial Officer and
Secretary
<PAGE>
THE RIGHT START, INC.
REPORT AND FINANCIAL STATEMENTS
JANUARY 30, 1999 AND JANUARY 31, 1998
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of The Right Start, Inc.
In our opinion, the financial statements listed in the index appearing under
Item 14(a) (1) and (2) on page 26 present fairly, in all material respects, the
financial position of The Right Start, Inc. at January 30, 1999 and January 31,
1998, and the results of its operations and its cash flows for the years ended
January 30, 1999 and January 31, 1998, the thirty-three weeks ended February 1,
1997 and the year ended June 1, 1996, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Los Angeles, California
March 12, 1999, except as to
Note 3, which is as of April 29, 1999
F-1
<PAGE>
THE RIGHT START, INC.
<TABLE>
<CAPTION>
BALANCE SHEET
-------------
January 30, January 31,
1999 1998
---- ----
ASSETS
------
<S> <C> <C>
Current assets:
Cash $ 626,000 $ 240,000
Accounts and other receivables 585,000 405,000
Merchandise inventories 5,797,000 6,602,000
Prepaid catalog costs 363,000 297,000
Other current assets 929,000 1,364,000
----------- -----------
Total current assets 8,300,000 8,908,000
Noncurrent assets:
Property, plant and equipment, net 7,884,000 8,115,000
Deferred income taxes 1,400,000 1,400,000
Other noncurrent assets 87,000 39,000
----------- -----------
$17,671,000 $18,462,000
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable and accrued expenses $ 3,822,000 $ 2,782,000
Revolving line of credit 2,014,000
----------- -----------
Term note payable 2,750,000
----------- -----------
Total current liabilities 6,572,000 4,796,000
Term note payable 3,000,000
Deferred rent 1,449,000 1,625,000
Senior subordinated notes, net of unamortized discount of $266,000 2,734,000
Subordinated convertible debentures 3,000,000
Commitments and contingencies
Mandatorily redeemable preferred stock Series A, $3,000,000 redemption value 1,789,000
Shareholders' equity:
Convertible preferred stock Series B 2,813,000
Convertible preferred stock Series C 3,850,000
Common stock (25,000,000 shares authorized at no par value;
5,051,820 shares issued and outstanding) 22,337,000 22,337,000
Additional paid-in capital 3,571,000
Accumulated deficit (24,710,000) (19,030,000)
------------ ------------
Total shareholders' equity 7,861,000 3,307,000
------------ ------------
$ 17,671,000 $ 18,462,000
============ ============
</TABLE>
See accompanying notes to financial statements.
F-2
<PAGE>
THE RIGHT START, INC.
STATEMENT OF OPERATIONS
-----------------------
<TABLE>
<CAPTION>
Year Ended Thirty-three
-------------------------- Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales:
Retail $31,875,000 $31,107,000 $19,576,000 $17,075,000
Catalog 4,736,000 7,414,000 7,635,000 23,293,000
Other revenues 877,000
----------- ----------- ----------- -----------
36,611,000 38,521,000 27,211,000 41,245,000
----------- ----------- ----------- -----------
Costs and expenses:
Cost of goods sold 18,576,000 19,244,000 14,417,000 21,605,000
Operating expense 15,371,000 19,212,000 12,608,000 18,282,000
General and administrative expense 3,459,000 3,912,000 2,941,000 4,341,000
Pre-opening costs 209,000 711,000 528,000 418,000
Depreciation and amortization expense 1,488,000 1,608,000 833,000 938,000
Other (income) expense (113,000) 1,905,000 851,000 450,000
----------- ----------- ----------- -----------
38,990,000 46,592,000 32,178,000 46,034,000
----------- ----------- ----------- -----------
Operating loss (2,379,000) (8,071,000) (4,967,000) (4,789,000)
Non-cash beneficial conversion feature amortization 3,850,000
Interest expense 640,000 1,143,000 204,000 37,000
----------- ----------- ----------- -----------
Loss before income taxes and extraordinary item (6,869,000) (9,214,000) (5,171,000) (4,826,000)
Income tax provision (benefit) 22,000 27,000 207,000 (927,000)
----------- ----------- ----------- -----------
Loss before extraordinary item (6,891,000) (9,241,000) (5,378,000) (3,899,000)
Extraordinary gain on debt restructuring 1,211,000
----------- ----------- ----------- -----------
Net loss $(5,680,000) $(9,241,000) $(5,378,000) $(3,899,000)
=========== =========== =========== ===========
Basic and diluted loss per share:
Loss before extraordinary item $(1.37) $(2.01) $(1.34) $(1.19)
Extraordinary item 0.24
----------- ----------- ----------- -----------
Net loss $(1.13) $(2.01) $(1.34) $(1.19)
=========== =========== =========== ===========
Weighted average number of common
shares outstanding 5,051,820 4,594,086 4,003,095 3,268,407
=========== =========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
THE RIGHT START, INC.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------
<TABLE>
<CAPTION>
Common Stock Additional
------------------ Paid-in Accumulated
Shares Amount Capital Deficit
------ ------ ---------- -------
<S> <C> <C> <C> <C>
Balance at May 31, 1995 3,150,000 $11,206,000 ($512,000)
Issuance of shares pursuant to a rights offering 789,403 4,906,000
Issuance of shares pursuant to the exercise
of stock options 30,250 201,000
Net loss (3,899,000)
----------- ----------- ------------
Balance at June 1, 1996 3,969,653 16,313,000 (4,411,000)
Issuance of shares pursuant to the exercise
of stock options 107,167 648,000
Net loss (5,378,000)
----------- ----------- ------------
Balance at February 1, 1997 4,076,820 16,961,000 (9,789,000)
Issuance of shares pursuant to the exercise
of stock options 220,000 1,320,000
Issuance of shares pursuant to a private placement 755,000 3,705,000
Issuance of common stock warrants in conjunction
with sale of senior subordinated notes 351,000
Net loss (9,241,000)
----------- ----------- ------------
Balance at January 31, 1998 5,051,820 22,337,000 (19,030,000)
Issuance of subordinated debt in conjunction
with recapitalization, net (Note 12) $3,590,000
Accretion of mandatorily redeemable
preferred stock Series A (19,000)
Net loss (5,680,000)
----------- ----------- ----------- ------------
Balance at January 30, 1999 5,051,820 $22,337,000 $3,571,000 ($24,710,000)
=========== =========== =========== ============
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
THE RIGHT START, INC.
STATEMENT OF CASH FLOWS
-----------------------
<TABLE>
<CAPTION>
Year Ended Thirty-three
--------------------------- Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss ($ 5,680,000) ($9,241,000) ($5,378,000) ($3,899,000)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,538,000 2,319,000 1,361,000 1,356,000
Non-cash beneficial conversion feature
amortization 3,850,000
Amortization of discount on senior
subordinated notes 44,000 85,000
Loss on store closings 39,000 1,580,000
Extraordinary gain (1,211,000)
Change in assets and liabilities affecting
operations 1,760,000 (1,316,000) (957,000) 506,000
----------- ----------- ------------ ------------
Net cash provided by (used in)
operating activities 340,000 (6,573,000) (4,974,000) (2,037,000)
----------- ----------- ------------ ------------
Cash flows from investing activities:
Additions to property, plant and equipment (1,296,000) (2,063,000) (3,607,000) (4,165,000)
Proceeds from sale of telemarketing center 298,000
----------- ----------- ------------ ------------
Net cash used in investing activities (1,296,000) (2,063,000) (3,309,000) (4,165,000)
----------- ----------- ------------ ------------
Cash flows from financing activities:
Net proceeds from (payments on) revolving
line of credit (2,014,000) 181,000 1,833,000
Proceeds from (payments on) note payable (250,000) 357,000 2,643,000
Proceeds from sale of convertible subordinated
debentures 3,000,000
Proceeds from private placement of common
stock 3,705,000
Proceeds from common stock issued upon exercise
of stock options 1,320,000 648,000 201,000
Proceeds from common stock issued pursuant to a
rights offering 4,906,000
Proceeds from sale of senior subordinated notes,
net 3,606,000 3,000,000
----------- ----------- ------------ ------------
Net cash provided by financing activities 1,342,000 8,563,000 8,124,000 5,107,000
----------- ----------- ------------ ------------
Net increase (decrease) in cash 386,000 (73,000) (159,000) (1,095,000)
Cash at beginning of period 240,000 313,000 472,000 1,567,000
----------- ----------- ------------ ------------
Cash at end of period $ 626,000 $ 240,000 $ 313,000 $ 472,000
=========== =========== ============ ============
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
THE RIGHT START, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
NOTE 1 - THE COMPANY AND ITS SIGNIFICANT ACCOUNTING POLICIES:
- ------------------------------------------------------------
The Company
- -----------
The Right Start, Inc. (the Company) is a specialty merchant of infants' and
children's products throughout the United States. In 1991, the Company
completed the sale of 2,300,000 shares of its common stock in an initial public
offering. Prior to that, it was a wholly owned subsidiary of American
Recreation Centers, Inc. (ARC). ARC maintained majority ownership of the
Company through July 1995. In August 1995, an investment group led by Kayne,
Anderson Investment Management, Inc. (KAIM) acquired the 3,937,000 shares of
common stock owned by ARC.
Fiscal Year
- -----------
The Company has a fiscal year consisting of fifty-two or fifty-three weeks
ending on the Saturday closest to the last day in January. Effective January
1997, the Company changed its fiscal year which had been the fifty-two or fifty-
three weeks ending on the Saturday closest to the last day in May. The change
in year end resulted in a thirty-three week transition period from June 2, 1996
to February 1, 1997 ("the Transition Period"). The fiscal years ended January
30, 1999 ("Fiscal 1998"), January 31, 1998 ("Fiscal 1997"), and June 1, 1996
("Fiscal 1996") were fifty-two week periods. See Note 15.
Revenue Recognition
- -------------------
Retail sales are recorded at time of sale or when goods are delivered. Catalog
sales are recorded at the time of shipment. The Company provides for estimated
returns at the time of the sale.
Merchandise Inventories
- -----------------------
Merchandise inventories consist of products purchased for resale and are stated
at the lower of cost or market value. Cost is determined on a first-in, first-
out basis.
Prepaid Catalog Expenses
- ------------------------
Prepaid catalog expenses consist of the costs to produce, print and distribute
catalogs. These costs are amortized over the expected sales life of each
catalog which does not exceed four months. Catalog production expenses of
$1,363,000, $2,753,000, $1,844,000 and $6,061,000 were recorded in Fiscal 1998,
Fiscal 1997, the Transition Period and Fiscal 1996, respectively.
Property, Plant and Equipment
- -----------------------------
Property, plant and equipment are stated at cost less accumulated depreciation.
Depreciation is provided using the straight-line method based upon the estimated
useful lives of the assets, generally three to ten years. Amortization of
leasehold improvements is based upon the term of the lease or the estimated
useful life of the leasehold improvements, whichever is shorter.
F-6
<PAGE>
NOTE 1: (Continued)
- ------
Long-lived Assets
- -----------------
The Company periodically evaluates whether events and circumstances have
occurred that indicate the remaining estimated useful life of long-lived assets
may warrant revision or that the remaining balance may not be recoverable. When
factors indicate that the asset should be evaluated for possible impairment, the
Company uses an estimate of the stores' undiscounted net cash flows over the
remaining life of the asset in measuring whether the asset is recoverable.
Based upon the anticipated future income and cash flow from operations, there
has been no impairment.
Store Opening Costs
- -------------------
Effective October 1, 1997, the Company changed the way costs incurred in opening
stores are recognized. Previously, these costs had been deferred and amortized
over 12 months commencing with the store opening. After the effective date, any
pre-opening costs incurred for new stores were charged to expense as incurred.
The impact of this change was not significant to the Company's results of
operations or financial position.
Deferred Rent
- -------------
The Company recognizes rent expense on the straight-line basis over the life of
the underlying lease. The benefit from tenant allowances and landlord
concessions are recorded as deferred rent and recognized over the lease term.
Income Taxes
- ------------
The Company accounts for income taxes using an asset and liability approach
under which deferred tax liabilities and assets are recognized for the expected
future tax consequences of temporary differences between the carrying amounts
and the tax bases of assets and liabilities. A valuation allowance is
established against deferred tax assets when it is more likely than not that
all, or some portion, of such deferred tax assets will not be realized.
During the periods that the Company was majority owned by ARC, the Company
provided for income taxes as a separate taxpayer. State income taxes were
settled pursuant to an informal tax sharing agreement and the Company filed a
separate federal income tax return.
Per Share Data
- --------------
On December 15, 1998, the Company's shareholders approved a one-for-two reverse
split of the Company's common stock, which had previously been approved by the
Company's Board of Directors. The reverse split was effective December 15,
1998. All references in the financial statements to shares and related prices,
weighted average number of shares, per share amounts and stock plan data have
been adjusted to reflect the reverse split.
Basic per share data is computed by dividing net loss applicable to common
shareholders by the weighted average number of common shares outstanding.
Diluted per share data is computed by dividing income available to common
shareholders plus income associated with dilutive securities by the weighted
average number of shares outstanding plus any potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock in each year.
F-7
<PAGE>
NOTE 1: (Continued)
- ------
<TABLE>
<CAPTION>
Year Ended Thirty-three
------------------------- Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
----------- ----------- ------------ ----------
<S> <C> <C> <C> <C>
Loss before extraordinary item $6,891,000 $9,241,000 $5,378,000 $3,899,000
Plus: Preferred stock accretion 19,000
----------- ----------- ------------ ----------
Basic and diluted loss before
extraordinary item applicable to
common shareholders $6,910,000 $9,241,000 $5,378,000 $3,899,000
========== ========== ========== ==========
</TABLE>
Securities that could potentially dilute basic EPS in the future were not
included in the computation of diluted EPS, because to do so would have been
antidilutive for the periods presented. Such securities include options
outstanding to purchase 890,519, 326,005, 489,960, and 523,701 shares of common
stock at January 30, 1999, January 31, 1998, February 1, 1997 and June 1, 1996,
respectively, Series B preferred stock convertible into 1,000,000 shares of
common stock and Series C preferred stock convertible into 1,925,000 shares of
common stock at January 30, 1999.
Stock-Based Compensation
- ------------------------
Compensation cost attributable to stock option plans is recognized based on the
difference, if any, between the closing market price of the stock on the date of
grant over the exercise price of the option. The Company has not issued any
stock options with an exercise price less than the closing market price of the
stock on the date of grant.
Reclassifications
- -----------------
Certain reclassifications have been made to conform prior period amounts to
current year presentation.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Comprehensive Income
- --------------------
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). This statement divides comprehensive income into net income and other
comprehensive income. SFAS 130 was effective for the Company during Fiscal
1998. The Company has no items of other comprehensive income in any period
presented and, consequently, is not required to report comprehensive income.
F-8
<PAGE>
NOTE 2 - PROPERTY, PLANT AND EQUIPMENT, NET:
- -------------------------------------------
<TABLE>
<CAPTION>
January 30, January 31,
1999 1998
---- ----
<S> <C> <C>
Property, plant and equipment, at cost:
Machinery, furniture and equipment $ 4,015,000 $ 3,669,000
Leaseholds and leasehold improvements 7,511,000 6,683,000
Computer software 840,000 821,000
----------- -----------
12,366,000 11,173,000
Accumulated depreciation and amortization (4,482,000) (3,058,000)
----------- -----------
$ 7,884,000 $ 8,115,000
=========== ===========
</TABLE>
Depreciation and amortization expense for property, plant and equipment amounted
to $1,488,000; $1,608,000; $833,000 and $938,000 for Fiscal 1998, Fiscal 1997,
the Transition Period and Fiscal 1996, respectively.
NOTE 3 - CREDIT AGREEMENTS:
- --------------------------
In November 1996, the Company entered into an agreement with a financial
institution for a $13 million credit facility (the "Credit Facility"). The $13
million facility consists of a $3 million capital expenditure facility (the
"Capex Line") and a $10 million revolving credit line for working capital (the
"Revolver"). Availability under the Revolver is subject to a defined borrowing
base. As of January 30, 1999, no borrowings were outstanding and $3,054,000 was
available under the Revolver. As of January 30, 1999, $2,750,000 was
outstanding on the Capex Line. The Credit Facility, as amended, requires the
Company at all times to maintain net worth (defined to include equity and
subordinated debt) of at least $8 million and provides that cash dividends may
be paid only if written consent of the lender is obtained. The Credit Facility
also limits the Company's earnings before interest, taxes, depreciation and
amortization (EBITDA) to the following loss amounts: $900,000 for the twelve
months ended January 31, 1999 and $500,000 for the twelve months ending April
30, 1999. Minimum EBITDA of zero is required for the twelve months ending July
31, 1999 and $400,000 for the twelve months ending October 31, 1999. In
addition, capital expenditures are limited to $1,750,000 in fiscal year 1999.
Interest accrues on the revolving line of credit at prime plus 1% and at prime
plus 1 1/2% on the capital expenditure facility. At January 30, 1999, the
bank's prime rate of interest was 7.75%. The Company's weighted average
interest rate on short-term borrowings was 9.43% and 9.48% for Fiscal 1998 and
Fiscal 1997, respectively.
The Credit Facility is for a period of three years and is secured by
substantially all the Company's assets. The Company plans to replace the Credit
Facility by November 1999, and believes that it could extend the Credit Facility
to May 2000.
F-9
<PAGE>
NOTE 3: (Continued)
- ------
Effective May 6, 1997, the Company sold subordinated notes in the aggregate
principal amount of $3,000,000 and warrants to purchase common stock, certain of
the purchasers of which were affiliates of the Company. The subordinated notes
bore interest at 11.5% and were due in full on May 6, 2000. Warrants to
purchase an aggregate of 237,500 shares of common stock at $6.00 per share were
issued in connection with the subordinated notes. Proceeds from the sale of the
subordinated notes and warrants were allocated to the debt security and the
warrants based on the fair value of the securities at the date of issuance. The
value assigned to the warrants was $351,000. The resulting debt discount was
amortized over the term of the notes. In December 1998, the holders of the
notes exchanged the notes and warrants in connection with a capital
restructuring. See Note 12.
The Company issued and sold subordinated convertible debentures in the aggregate
principal amount of $3 million effective October 11, 1996. The terms of such
debentures, as amended, permitted the holders to convert the principal amount
into 375,000 shares of the Company's common stock at $8.00 per share at any time
prior to May 31, 2002, the due date of the debentures. The debentures bore
interest at a rate of 8% per annum. The holders of the debentures exchanged the
debentures in conjunction with a capital restructuring in December 1998. See
Note 12.
NOTE 4 - MANDATORILY REDEEMABLE PREFERRED STOCK:
- -----------------------------------------------
In connection with the Company's recapitalization (see Note 12), the Company
issued 30,000 shares of mandatorily redeemable preferred stock Series A. The
stock has a par value of $.01 per share and a liquidation preference of $100 per
share; it is mandatorily redeemable at the option of the holders on May 31, 2002
at a redemption price of $100 per share or $3,000,000. The Series A preferred
stock shall also be redeemed by the Company upon a change of control or upon the
issuance of equity securities by the Company for proceeds in excess of
$15,000,000, both as defined in the Certificate of Determination for the Series
A preferred stock.
The difference in the fair value of the mandatorily redeemable Series A
preferred stock at the date of issuance and the redemption amount is being
accreted, using the interest method, over the period from the issuance date to
the required redemption date as a charge to additional paid-in capital.
There shall be no dividends on the Series A preferred stock unless the Company
is unable to redeem the stock at the required redemption date, at which point
dividends shall cumulate and accrue on a daily basis, without interest, at the
rate of $15.00 per share per annum, payable quarterly.
NOTE 5 - SHAREHOLDERS' EQUITY:
- -----------------------------
Pursuant to shareholder approval in December 1998, the Company authorized for
issuance 250,000 shares of preferred stock, of which 30,000 were designated
Series A (see Note 4), 30,000 were designated for Series B and 38,500 were
designated for Series C. In connection with the Company's recapitalization (see
Note 12), the Company issued the Series A, Series B and Series C shares
(collectively, the "Preferred Shares").
The Preferred Shares are non-voting. However, holders of at least a majority of
the Preferred Shares acting as a class, must consent to certain corporate
actions, including the sale of the Company, as defined in the respective
Certificates of Determination.
F-10
<PAGE>
NOTE 5: (Continued)
- ------
Both Series B and Series C preferred stock have a par value of $.01 per share
and a liquidation preference of $100 per share. The shares shall be convertible
in whole or in part at any time at the option of the holders into shares of the
Company's common stock. The conversion rates are $3.00 per common share and
$2.00 per common share for the Series B preferred stock and the Series C
preferred stock, respectively, subject to anti-dilution provisions set forth in
the Certificates of Determination for the Series B and the Series C preferred
stock.
NOTE 6 - INCOME TAXES:
- ---------------------
The provision (benefit) for income taxes is comprised of the following:
<TABLE>
<CAPTION>
Year Ended Thirty-three
------------------------------ Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Current provision:
Federal $ 1,000
State $ 22,000 $ 27,000
Deferred provision (benefit):
Federal (928,000)
State
Adjustment to valuation allowance $ 207,000
------------- ------------- ------------- ------------
$ 22,000 $ 27,000 $ 207,000 ($ 927,000)
============= ============== ============= ============
</TABLE>
The Company's effective income tax rate differed from the federal statutory rate
as follows:
<TABLE>
<CAPTION>
Year Ended Thirty-three
------------------------------ Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Federal statutory rate 34% 34% 34% 34%
State income taxes, net of federal
benefit 3 1 3
Stock options 4
Valuation allowance (11) (39) (45) (19)
Debt discount amortization (23)
Other 2 2 1
------------- ------------- ------------ -------------
Effective tax rate 0% 0% (4)% 19%
============= ============= ============ =============
</TABLE>
F-11
<PAGE>
NOTE 6: (Continued)
- ------
Deferred tax liabilities (assets) are comprised of the following:
<TABLE>
<CAPTION>
January 30, January 31,
1999 1998
------------- -------------
<S> <C> <C>
Depreciation and amortization $ 87,000 $ 200,000
Pre-opening costs 21,000
Other 27,000 64,000
------------- -------------
Deferred tax liabilities 114,000 285,000
------------- -------------
Net operating loss carryforwards (7,672,000) (6,799,000)
Deferred rent (604,000) (839,000)
Writedown of fixed assets (633,000)
Other reserves (868,000) (396,000)
Other tax carryforwards (69,000) (68,000)
Sales returns (29,000) (29,000)
------------- -------------
Deferred tax assets (9,242,000) (8,764,000)
------------- -------------
Valuation allowance 7,728,000 7,079,000
------------- -------------
Net deferred tax asset ($ 1,400,000) ( $1,400,000)
============= =============
</TABLE>
In evaluating the realizability of the deferred tax asset, management considered
the Company's projections and available tax planning strategies. Management
expects that the Company will generate sufficient taxable income in future years
to utilize the net deferred tax asset. In addition, the Company could implement
certain tax planning strategies including the sale of the Company's catalog
operations or its catalog operation's mailing lists in order to generate income
to enable the Company to realize its NOL carryforwards.
The Company has federal and state net operating loss carryforwards at January
30, 1999 of $20,492,000 and $8,033,000, respectively. These carryforwards will
expire in fiscal years ending 2002 through 2019.
NOTE 7 - SALE OF TELEMARKETING CENTER:
- --------------------------------------
In July 1996, the Company sold its phone center operations to a telemarketing
services provider for approximately $500,000, $250,000 of which was in cash and
the remainder of which was in a two-year note secured by the assets of the phone
center. There was no gain or loss on the sale.
F-12
<PAGE>
NOTE 8 - EMPLOYEE BENEFITS AND STOCK OPTIONS:
- --------------------------------------------
On March 15, 1991, two now former executives were granted options to acquire up
to 450,000 shares of the Company's common stock under a non-qualified stock
option plan. The options were granted at fair market value of $6.66 per share.
One hundred fifty thousand options were exercisable at the date of grant. These
options expire June 1, 2001. In conjunction with the August 1995 renegotiation
of the employment contracts with these two executives, certain option terms were
amended. Each executive's holdings became 194,000 options exercisable at $6.00
per share, the fair market value at the time of reissuance. At January 30,
1999, 40,500 shares were outstanding under this plan.
One of the executives covered by these option agreements was the Company's chief
executive officer who resigned in March 1996. The other executive covered by
these option agreements was the Company's president who resigned in October
1996. The employment contracts for these individuals called for severance
payments in aggregate of approximately $930,000. A significant portion of each
individual's severance represented the cash surrender value of a life insurance
policy and the remainder was paid out through December 1997.
The Company adopted the 1991 Employee Stock Option Plan, covering an aggregate
of 725,000 shares of the Company's common stock, in October 1991. Options
outstanding under this plan have terms ranging from three to ten years
(depending on the terms of the individual grant). In May 1998, certain option
holders were given the right to cancel their existing options (many of which
were vested) (the "Existing Options") and have new options issued to them at the
fair market value on the date of grant of $3.50 per share (the "New Options").
The Existing Options vested 33% per annum. The New Options vest 20% in the
first year and 40% per annum thereafter. In December 1998, the Company granted
275,000 options which vest immediately upon the attainment of a closing stock
price, as defined in the grant agreements, of $6.50 for thirty consecutive
trading days. Other options granted under this plan, representing 47,320 of the
696,160 outstanding options, vest fully one year after grant date. At January
30, 1999, there were no Existing Options outstanding. Options for 11,991 shares
were exercisable at January 30, 1999.
In October 1995, the Company adopted the 1995 Non-Employee Directors Option
Plan. This Plan provides for the annual issuance, to each non-employee
director, of options to purchase 1,500 shares of common stock. In addition,
each director is entitled to make an election to receive, in lieu of directors'
fees of $12,000 per year, additional options to purchase common stock. The
amount of additional options is determined based on an independent valuation
such that the fair value of the options issued is equivalent to the fees that
the director would be otherwise entitled to receive on an annual basis. Options
issued under this plan vest on the anniversary date of their grant and upon
termination of Board membership. These options expire three to five years from
the date of grant. Options to purchase 153,859 shares of common stock were
issued under this plan at exercise prices ranging from $2.50 to $10.26 per
share, such exercise price being equal to the closing price of the Company's
common stock on the date of grant. No compensation cost was recognized in
income in connection with options granted under the Non-Employee Directors
Option Plan. At January 30, 1999, 95,515 of the options issued under this plan
were exercisable.
In 1993, the Company adopted an employee stock ownership plan (ESOP) and
employee stock purchase plan (ESPP) for the benefit of its employees. The ESOP
is funded exclusively by discretionary contributions determined by the Board of
Directors. The Board of Directors authorized contributions to the ESOP of
$70,000 in Fiscal 1996. The Company matches employees' contributions to the ESPP
at a rate of 50%. The Company's contributions to the ESPP amounted to $14,000,
$24,000, $21,000, $28,000 in Fiscal 1998, Fiscal 1997, the Transition Period and
Fiscal 1996, respectively.
F-13
<PAGE>
NOTE 8: (Continued)
- ------
The following table summarizes option activity through January 30, 1999:
<TABLE>
<CAPTION>
Weighted
Number Average
of Options Exercise Price
------------ ---------------
<S> <C> <C>
Outstanding at May 31, 1995 521,000 $ 6.98
Granted 153,451 8.54
Canceled (120,500) 6.20
Exercised (30,250) 6.38
-------------
Outstanding at June 1, 1996 523,701 6.80
Granted 81,760 10.54
Canceled (8,334) 6.84
Exercised (107,167) 6.04
------------
Outstanding at February 1, 1997 489,960 7.40
Granted 98,295 5.00
Canceled (42,250) 8.08
Exercised (220,000) 6.00
------------
Outstanding at January 31, 1998 326,005 7.62
Granted 785,014 3.03
Canceled (220,500) 7.13
------------
Outstanding at January 30, 1999 890,519 3.72
============
</TABLE>
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>
Year Ended Thirty-three
------------------------------ Weeks Ended Year Ended
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Net loss:
As reported ($ 5,680,000) ($9,241,000) ($5,378,000) ($3,899,000)
Pro forma (6,258,000) (9,640,000) (5,839,000) (4,068,000)
Basic and diluted loss per share:
As reported ($1.13) ($2.01) ($1.34) ($1.19)
Pro forma (1.24) (2.10) (1.46) (1.25)
</TABLE>
F-14
<PAGE>
NOTE 8: (Continued)
- ------
These pro forma amounts may not be representative of future disclosures since
the estimated fair value of stock options is amortized to expense over the
vesting period, and additional options may be granted in future years. The fair
value for these options was estimated at the date of grant using the Black-
Scholes options-pricing model with the following weighted-average assumptions
for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996,
respectively: dividend yields of zero percent; expected volatility of 76.91,
79.34, 73.25 and 70.97 percent; risk-free interest rates of 5.17, 6.00, 6.36 and
6.10 percent; and expected life of four years for all periods. The weighted
average fair value of options granted during Fiscal 1998, Fiscal 1997, the
Transition Period and Fiscal 1996 for which the exercise price equals the market
price on the grant date was $1.07, $1.55, $3.10 and $4.78, respectively.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of employee stock options.
The following table summarizes information concerning outstanding and
exercisable stock options at January 30, 1999:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Range of exercise prices $2.50 - $3.75 $3.76 - $5.50 $5.51 - $8.25 $8.26 - $10.26
Number of outstanding options 742,513 44,296 40,500 63,210
Weighted average remaining
contractual life 8.9 years 3.3 years 6.3 years 2.0 years
Weighted average exercise price $ 3.05 $ 5.00 $ 6.00 $ 9.41
Number of options exercisable - 44,294 40,500 63,212
Weighted average exercise price of
options exercisable - $ 5.00 $ 6.00 $ 9.40
</TABLE>
NOTE 9 - RELATED PARTY TRANSACTIONS:
- ------------------------------------
KAIM provides certain management services to the Company and charges the Company
for such services. Management fees of $100,000, $100,000, $66,667 and $83,333
were paid to KAIM in Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal
1996, respectively.
The Company provided telemarketing services through July 1996, to K.A.
Industries, a related party to KAIM. Revenues generated from this service
amounted to $40,000 for the Transition Period and $365,000 for Fiscal 1996.
Management believes that the terms of this agreement were no less favorable than
those that would have been negotiated with an unrelated third party.
F-15
<PAGE>
NOTE 10 - COMMITMENTS AND CONTINGENCIES:
- ----------------------------------------
The Company leases real property and equipment under non-cancelable agreements
expiring from 1999 through 2007. Certain retail store lease agreements provide
for contingent rental payments if the store's net sales exceed stated levels
("percentage rents"). Certain other of the leases contain escalation clauses
which provide for increases in base rental for increases in future operating
cost and renewal options at fair market rental rates. The Company's minimum
rental commitments are as follows:
<TABLE>
<CAPTION>
Fiscal Year
-----------
<S> <C>
1999 $ 3,461,000
2000 3,506,000
2001 3,460,000
2002 3,283,000
2003 2,922,000
Thereafter 5,073,000
-------------
$ 21,705,000
=============
</TABLE>
Net rental expense under operating leases was $3,233,000, $3,802,000, $1,929,000
and $1,959,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal
1996, respectively. No percentage rents were incurred in Fiscal 1998 and Fiscal
1997; percentage rents incurred in the Transition Period and Fiscal 1996
amounted to $54,000 and $82,000, respectively. The Company recognizes
percentage rent expense when it is probable that it will be incurred.
The Company is not a party to any material legal actions.
NOTE 11 - STORE CLOSINGS:
- -------------------------
On December 16, 1997, the Board of Directors of the Company approved
management's plan to close seven poor-performing retail stores. The Company
wrote off $1.3 million of the net carrying value of capitalized leasehold
improvements and fixed assets related to these stores, which is included in
other expenses in the statement of operations. The revenues from the stores
which closed were $1,904,000, $4,663,000, $3,003,000 and $2,802,000 for Fiscal
1998, Fiscal 1997, the Transition Period and Fiscal 1996, respectively.
Operating losses from these stores were $17,000, $435,000, $215,000 and $48,000
for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996,
respectively. All but one of these stores were closed in Fiscal 1998. The
remaining store is currently being closed.
On January 28, 1997, the Board of Directors of the Company approved management's
plan to close two poor-performing retail stores. The Company wrote off $425,000
of the net carrying value of capitalized leasehold improvements and fixed assets
related to these stores, which is included in other expenses in the statement of
operations. The revenues from these stores were $99,000, $802,000, $616,000 and
$1,170,000 for Fiscal 1998, Fiscal 1997, the Transition Period and Fiscal 1996,
respectively. Operating losses from these stores were $42,000, $167,000,
$225,000 and $155,000 for Fiscal 1998, Fiscal 1997, the Transition Period and
Fiscal 1996, respectively. These stores were closed in Fiscal 1998.
F-16
<PAGE>
NOTE 12 - RECAPITALIZATION AND EXTRAORDINARY GAIN:
- --------------------------------------------------
In order to enhance the Company's liquidity and improve its capital structure,
effective April 13, 1998 the Company completed a private placement of non-
interest bearing senior subordinated notes in an aggregate principal amount of
$3,850,000, together with detachable warrants to purchase an aggregate of
1,925,000 shares of common stock exercisable at $2.00 per share (the "New
Securities"). The New Securities were sold for an aggregate purchase price of
$3,850,000 and were purchased principally by affiliates of the Company.
In connection with the sale of the New Securities, the Company entered into an
agreement (the "Agreement") with all of the holders of the Company's existing
subordinated debt and warrant securities representing an aggregate principal
amount of $6,000,000. Pursuant to the Agreement, each holder (of new and old
securities) agreed to exchange all of its subordinated debt securities together
with any warrants issued in connection therewith, for newly issued preferred
stock. The issuance of the shares of preferred stock was subject to the
approval of the Company's shareholders, which approval was received on December
15, 1998.
Ten shares of newly issued preferred stock were issued for each $1,000 principal
amount of subordinated debt securities exchanged. The total number of shares
issued were 30,000, 30,000 and 38,500 for Series A, B and C Preferred Stock,
respectively.
Holders of $3,000,000 principal amount of existing subordinated debt securities
elected to receive Series A Preferred Stock which has no fixed dividend rights,
is not convertible into common stock, is mandatorily redeemable by the Company
in May 2002 and does not accrue dividends unless the Company is unable to redeem
the Series A Preferred Stock at the required redemption date, at which point
dividends would begin to accumulate and accrue at a rate of $15 per share per
annum.
Holders of $3,000,000 principal amount of existing subordinated debt securities
elected to receive Series B convertible preferred stock which has no fixed
dividend rights and is convertible into common stock at a price per share of
$3.00.
Holders of the $3,850,000 principal amount of New Securities elected to receive
Series C convertible preferred stock which has no fixed dividend rights and is
convertible into common stock at a price per share of $2.00.
As the $3.85 million of New Securities were issued in contemplation of the
exchange into convertible preferred stock, the accounting for the New Securities
is analogous to convertible debt. The New Securities were to be exchanged for
Series C preferred stock which were convertible into common stock at a price per
share of $2.00. As of the date of issue of the New Securities, the stock was
trading at $4.00 a share. Since the conversion feature was in the money at the
date of issue of the debt, the portion of the debt proceeds equal to the
beneficial conversion feature of $3.85 million was allocated to additional paid-
in capital. The resulting debt discount of $3,850,000 was amortized to interest
expense over the period from the April issuance date to the date the New
Securities were first convertible. The date the New Securities were first
convertible was the exchange date when the New Securities were exchanged for
convertible preferred stock. No value was assigned to the warrants because the
requirement to exchange the warrants, together with the debt, for preferred
stock resulted in an assessment that the warrants has no independent value apart
from the exchange transaction.
F-17
<PAGE>
NOTE 12: (Continued)
- -------
The exchanges of the subordinated debt and warrant securities for the preferred
stock were recorded at the date of issuance of the preferred stock. The fair
value of each preferred stock series was determined as of the issuance date of
the stock. The difference between the fair value of the Series A preferred
stock granted of $1,769,000 and the carrying amount of the related subordinated
debt security's balance exchanged of $3,000,000 was recognized as a gain on the
extinguishment of debt, net of transaction expenses, in the amount of
$1,231,000. The difference between the fair value of the Series B preferred
stock series granted of $2,812,000 and the carrying amount of the related
subordinated debt security's balance plus accrued interest exchanged of
$2,828,000 was recognized as a gain on the extinguishment of debt, net of
transaction expenses, in the amount of $16,000 with $8,000 of the gain on the
exchange of notes held by principal shareholders recorded as a credit to
additional paid-in capital. There was no gain or loss recognized on the
conversion of the New Securities.
In connection with the above restructuring, effective April 13, 1998, the
holders of the Company's $3.0 million subordinated notes and $3.0 million
subordinated convertible debentures agreed to waive their right to receive any
and all interest payments accrued and owing on or after February 28, 1998. This
modification of terms was accounted for prospectively, from the effective date,
under Statement of Financial Accounting Standards No. 15, "Accounting of Debtors
and Creditors for Troubled Debt Restructurings," as follows.
The carrying amount of the subordinated notes as of April 13, 1998 was not
changed as the carrying amount of the debt did not exceed the total future cash
payments of $3.0 million specified by the new terms. Interest expense was
computed using the interest method to apply a constant effective interest rate
to the payable balance between the modification date of April 13, 1998, and the
original maturity date of the payable in May 2000.
The total future cash payments specified by the new terms of the convertible
debentures of $3.0 million is less than the carrying amount of the liability to
the debenture holders of $3,027,000, therefore, the carrying amount was reduced
to an amount equal to the total future cash payments specified by the new terms
and the Company recognized a gain on restructuring of payables equal to the
amount of the reduction as of April 13, 1998. No interest expense was
recognized on the payable for any period between the modification date of April
13, 1998 and the date the debentures were exchanged for preferred stock.
Proceeds from the Company's private placement of New Securities in the amount of
$3,850,000 were used to pay off the Company's revolving line of credit.
Further, the Company's lender amended the existing loan agreement to provide
more favorable terms which are consistent with management's financial and
operating plans. These plans include the closure of certain unprofitable mall
stores and opening of other store locations.
As a result of the above, management believes that it has sufficient liquidity
to execute its current plan. However, the Company's ability to fund its
operations, open new stores and maintain compliance with its loan agreement is
dependent on its ability to generate sufficient cash flow from operations and
obtain additional financing as described in Note 3. Historically, the Company
has incurred losses and may continue to incur losses in the near term.
Depending on the success of its business strategy, the Company may continue to
incur losses beyond such period. Losses could negatively affect working capital
and the extension of credit by the Company's suppliers and impact the Company's
operations.
F-18
<PAGE>
NOTE 13 - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
- ----------------------------------------------------------
Changes in assets and liabilities which increased (decreased) cash are as
follows:
<TABLE>
<CAPTION>
Thirty-three
Year Ended Weeks Ended Year Ended
------------------------------
January 30, January 31, February 1, June 1,
1999 1998 1997 1996
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Accounts and other receivables ($ 180,000) $ 733,000 ($ 529,000) ($126,000)
Merchandise inventories 805,000 1,062,000 (2,400,000) (122,000)
Other current assets 319,000 217,000 (1,109,000) (95,000)
Other noncurrent assets (48,000) (2,000) 113,000 142,000
Accounts payable and accrued expenses 1,040,000 (3,641,000) 1,975,000 1,030,000
Amounts due to ARC (71,000)
Deferred income taxes 207,000 (928,000)
Other liabilities (97,000)
Deferred rent (176,000) 315,000 786,000 773,000
------------- ------------- ------------ -------------
$ 1,760,000 ( $1,316,000) ($ 957,000) $ 506,000
============= ============= ============ =============
</TABLE>
Cash paid for income taxes was $3,000, $5,000 and $7,000 for Fiscal 1998, Fiscal
1997, and the Transition Period, respectively. Cash paid for interest was
$483,000, $954,000, $193,000 and $73,000 for Fiscal 1998, Fiscal 1997, the
Transition Period and Fiscal 1996, respectively. Non-cash investing activity
consists of a $250,000 note received upon the sale of the phone center
operations in the Transition Period.
NOTE - 14 NEW ACCOUNTING PRONOUNCEMENTS:
- -----------------------------------------
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5 "Reporting on the Costs of Start-up Activities" (SOP
98-5), which requires that the costs of start-up activities and organization
costs be expensed as incurred. The impact of the adoption of SOP 98-5 is not
expected to be material to the Company's financial position or results of
operations. Effective October 1, 1997 and as disclosed in Note 1, the Company
began expensing all store pre-opening costs as incurred.
F-19
<PAGE>
NOTE 15 - COMPARABLE PRIOR PERIOD DATA (Unaudited):
- --------------------------------------------------
As described in Note 1, the Company changed its fiscal year end effective
January 1, 1997, resulting in a thirty-three week transition period ending
February 1, 1997. Comparable results of operations for the thirty-three weeks
ended February 3, 1996 are as follows:
<TABLE>
<CAPTION>
<S> <C>
Net sales:
Catalog $16,573,000
Retail 9,894,000
Other revenues 749,000
-----------
27,216,000
Costs of goods sold 13,864,000
Other expenses, net 14,632,000
-----------
Loss before income taxes (1,280,000)
Income tax benefit 523,000
-----------
Net loss $ (757,000)
===========
Basic and diluted loss per share $ (0.24)
Weighted average number of common shares outstanding 3,151,267
===========
</TABLE>
NOTE 16 - SEGMENT INFORMATION:
- -----------------------------
In the Fiscal 1998 fourth quarter, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information". This statement supersedes Statement of Financial
Accounting Standards No. 14, "Financial Reporting for Segments of a Business
Enterprise", replacing the "industry segment" approach with the "management"
approach. The management approach designates the internal organization that is
used by management for making operating decisions and assessing performance as
the source of the company's reportable segments. This statement requires
disclosure of certain information by reportable segment, geographic area and
major customer. The Company is a specialty merchant of infants' and children's
products and operates only in one reportable segment for purposes of this
disclosure.
F-20
<PAGE>
THE RIGHT START, INC.
SCHEDULE II VALUATION RESERVES
<TABLE>
<CAPTION>
Additional
Balance at charged Balance at
beginning to costs end
Classification of period and expenses Deductions of period
- ------------------------------------------ --------------- ---------------- --------------- ----------------
Fiscal year ended January 30, 1999
- ----------------------------------
<S> <C> <C> <C> <C>
Allowance for deferred tax asset $7,079,000 $ 649,000 $7,728,000
Inventory reserve 121,000 369,000 $422,000 68,000
Allowance for sales returns 69,000 69,000
--------------- ---------------- --------------- ----------------
$7,269,000 $1,018,000 $422,000 $7,865,000
=============== ================ =============== ================
Fiscal year ended January 31, 1998
- ----------------------------------
Allowance for deferred tax asset $3,280,000 $3,799,000 $7,079,000
Inventory reserve 81,000 425,000 $385,000 121,000
Allowance for sales returns 103,000 34,000 69,000
-------------- ---------------- --------------- ----------------
$3,464,000 $4,224,000 $419,000 $7,269,000
=============== ================ =============== ================
Thirty-three weeks ended February 1, 1997
- ------------------------------------------
Allowance for deferred tax asset $ 940,000 $2,340,000 $3,280,000
Inventory reserve 86,000 267,000 $272,000 81,000
Allowance for sales returns 103,000 103,000
--------------- ---------------- --------------- ----------------
$1,129,000 $2,607,000 $272,000 $3,464,000
=============== ================ =============== ================
Fiscal year ended June 1, 1996
- ------------------------------------------
Allowance for deferred tax asset $ 940,000 $ 940,000
Inventory reserve 490,000 $404,000 86,000
Allowance for sales returns $ 103,000 103,000
--------------- ---------------- --------------- ----------------
$ 103,000 $1,430,000 $404,000 $1,129,000
=============== ================ =============== ================
</TABLE>
F-21
<PAGE>
Exhibit 23.1
Consent of Independent Accountants
----------------------------------
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-3 (No. 333-08157) and in the Registration Statements on Form
S-8 (No. 333-217149 and No. 333-21747) of The Right Start, Inc. of our report
dated March 12, 1999, except as to Note 3, which is as of April 29, 1999,
relating to the financial statements and financial statement schedule, which
appears in this Form 10-K/A.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Los Angeles, California
May 26, 1999
