<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
Form 10-Q
================================================================================
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_____________to ___________
Commission File Number 0-19536
THE RIGHT START, INC.
---------------------
(Exact name of registrant as specified by its charter)
California 95-3971414
---------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organiztion) Identification No.)
5388 Sterling Center Drive, Unit C, Westlake Village, CA 91361
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(Address of principal executive offices) (Zip Code)
(818) 707-7100
---------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No_______
-----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock Outstanding as of July 31, 1999 - 5,059,203 shares
<PAGE>
THE RIGHT START, INC.
INDEX TO FORM 10-Q
FOR THE THIRTEEN AND TWENTY - SIX WEEK PERIODS
ENDED JULY 31, 1999
PART I - FINANCIAL INFORMATION
<TABLE>
<S> <C>
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 15
SIGNATURES 16
</TABLE>
2
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THE RIGHT START, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
July 31, January 30,
1999 1999
--------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 14,765,000 $ 626,000
Accounts and other receivables 691,000 585,000
Merchandise inventories 6,471,000 5,797,000
Prepaid catalog costs 228,000 363,000
Other current assets 1,213,000 929,000
------------ ------------
Total current assets 23,368,000 8,300,000
Property, plant and equipment, net 8,932,000 7,884,000
Deferred income taxes 1,400,000 1,400,000
Other noncurrent assets 118,000 87,000
------------ ------------
$ 33,818,000 $ 17,671,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 4,398,000 $ 3,349,000
Accrued salaries and bonuses 508,000 433,000
Advance payments on orders 24,000 40,000
Revolving line of credit 2,332,000
Term note payable 2,250,000 2,750,000
------------ ------------
Total current liabilities 9,512,000 6,572,000
Deferred rent 1,429,000 1,449,000
Minority interest in consolidated subsidiary 15,000,000
Mandatorily redeemable preferred stock Series A,
$3,000,000 redemption value 1,932,000 1,789,000
Shareholders' equity:
Convertible preferred stock Series B 2,813,000 2,813,000
Convertible preferred stock Series C 3,850,000 3,850,000
Common stock (25,000,000 shares authorized
at no par value; 5,051,820 issued and outstanding) 22,374,000 22,337,000
Additional paid-in capital 4,354,000 3,571,000
Accumulated deficit (27,446,000) (24,710,000)
------------ ------------
$ 33,818,000 $ 17,671,000
============ =============
</TABLE>
See accompanying notes to consolidated financial statements
3
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THE RIGHT START, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
<TABLE>
<CAPTION>
Thirteen weeks ended Twenty-six weeks ended
---------------------------------- ---------------------------------
July 31, 1999 August 1, 1998 July 31, 1999 August 1, 1998
------------- -------------- ------------- --------------
<S> <C> <C> <C> <C>
Net sales:
Retail $ 9,464,000 $ 7,791,000 $18,499,000 $15,120,000
Internet 226,000 226,000
Catalog 869,000 964,000 2,555,000 2,676,000
----------- ----------- ----------- -----------
10,559,000 8,755,000 21,280,000 17,796,000
----------- ----------- ----------- -----------
Costs and expenses:
Cost of goods sold 5,206,000 4,571,000 10,321,000 9,156,000
Operating expense 4,609,000 3,836,000 8,790,000 8,049,000
General and administrative expense 981,000 855,000 1,890,000 1,777,000
Pre-opening costs 75,000 19,000 137,000 50,000
Depreciation and amortization expense 399,000 326,000 748,000 674,000
Minority interest in consolidated subsidiary (17,000) (17,000)
Other (income) and expense:
Non-cash compensation 1,770,000 1,770,000
Store closing (income) expense 151,000 39,000 151,000 (113,000)
----------- ----------- ----------- -----------
13,174,000 9,646,000 23,790,000 19,593,000
Operating loss (2,615,000) (891,000) (2,510,000) (1,797,000)
Interest expense 112,000 122,000 197,000 438,000
----------- ----------- ----------- -----------
Loss before income taxes and
extraordinary item (2,727,000) (1,013,000) (2,707,000) (2,235,000)
Income tax provision 20,000 5,000 29,000 17,000
----------- ----------- ----------- -----------
Loss before extraordinary item (2,747,000) (1,018,000) (2,736,000) (2,252,000)
Extraordinary gain on debt restructuring 27,000
----------- ----------- ----------- -----------
Net loss $(2,747,000) $(1,018,000) $(2,736,000) $(2,225,000)
=========== =========== =========== ===========
Basic and diluted loss per share $ (0.56) $ (0.20) $ (0.57) $ (0.44)
=========== =========== =========== ===========
Weighted average number of shares
outstanding 5,058,878 5,051,820 5,055,349 5,051,820
</TABLE>
See accompanying notes to consolidated financial statements
4
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THE RIGHT START, INC.
STATEMENTS OF CASH FLOWS
(unaudited)
<TABLE>
<CAPTION>
Twenty-six weeks ended
----------------------------------
July 31, 1999 August 1, 1998
------------- --------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $(2,736,000) $(2,225,000)
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Depreciation and amortization 748,000 725,000
Non-cash compensation 1,770,000
Store closing expense 151,000 39,000
Minority interest in consolidated subsidiary (17,000)
Amortization of discount on senior subordinated notes 40,000
Extraordinary gain (27,000)
Change in assets and liabilities affecting operations 64,000 107,000
----------- -----------
Net cash used in operating activities (20,000) (1,341,000)
----------- -----------
Cash flows from investing activities:
Additions to property, plant and equipment (1,575,000) (459,000)
----------- -----------
Net cash used in investing activities (1,575,000) (459,000)
----------- -----------
Cash flows from financing activities:
Net proceeds from (payments on) revolving line of credit 2,332,000 (2,014,000)
Payments on term note payable (500,000)
Proceeds from exercise of stock options 37,000
Sale of preferred stock in consolidated subsidiary, net 13,865,000
Proceeds from sale of senior subordinated notes, net 3,850,000
----------- -----------
Net cash provided by financing activities 15,734,000 1,836,000
----------- -----------
Net increase in cash and cash equivalents 14,139,000 36,000
Cash at beginning of period 626,000 240,000
----------- -----------
Cash and cash equivalents at end of period $14,765,000 $ 276,000
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
5
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THE RIGHT START, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: Description of Business and Significant Accounting Policies
The Right Start, Inc. is a specialty merchant offering unique, high-quality
juvenile products for infants and young children. The Company markets its
products through its retail stores, The Right Start Catalog and its Internet
site, www.rightstart.com.
The consolidated financial statements include the results of The Right
Start, Inc. and its newly formed, majority-owned subsidiary, Rightstart.com Inc.
Rightstart.com was formed in April 1999 for the purpose of engaging in
electronic commerce over the Internet. Effective May 1, 1999, the Company
contributed its catalog operations to Rightstart.com and in July 1999,
Rightstart.com issued preferred stock to certain investors representing 33%, on
a fully-diluted basis, of Rightstart.com's outstanding capital stock. The
preferred stock is reflected as minority interest in consolidated subsidiary in
the accompanying consolidated balance sheet at July 31, 1999.
There have been no changes in the Company's significant accounting policies
as set forth in the Company's financial statements for the year ended January
30, 1999. These unaudited financial statements as of July 31, 1999 and for the
thirteen and twenty-six week periods then ended have been prepared in accordance
with generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Certain reclassifications have been made to conform prior year amounts to
current year presentation.
Operating results for the thirteen and twenty-six week periods ended July
31, 1999 are not necessarily indicative of the results that may be expected for
the year ending January 29, 2000.
NOTE 2: 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 consolidated financial statements to shares and
related prices have been adjusted to reflect the reverse split.
Basic per share data is computed by dividing income available to common
shareholders by the weighted average number of common shares outstanding.
Diluted per share data is computed by dividing income available to common
shareholders plus income associated with dilutive securities by the weighted
average number of shares outstanding plus any potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock in each year.
<TABLE>
<CAPTION>
Thirteen Weeks Ended Twenty-six Weeks Ended
-------------------------------- --------------------------------
July 31, 1999 August 1, 1998 July 31, 1999 August 1, 1998
-------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C>
Income (loss) before extraordinary item $(2,747,000) $(1,018,000) $(2,736,000) $(2,252,000)
Preferred stock accretion (73,000) ___________ (143,000) __________
----------- -----------
Basic and diluted loss before extraordinary
item applicable to common shareholders $(2,820,000) $(1,018,000) $(2,879,000) $(2,252,000)
=========== =========== =========== ===========
</TABLE>
Securities that could potentially dilute basic EPS in the future that were
not included in the computation of diluted EPS because to do so would have been
antidilutive for the periods presented include options outstanding to purchase
701,161 and 644,000 shares of common stock at July 31, 1999 and August 1, 1998,
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 July 31, 1999.
6
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NOTE 3: Minority Interest
Minority interest represents the preferred stock issued by the Company's
subsidiary. Rightstart.com issued 3,333,333 shares of Series A Convertible
Preferred Stock, representing 33% of its fully-diluted capital stock, in
exchange for $15,000,000. Holders of the convertible preferred stock are
entitled to a liquidation preference in aggregate of $15,000,000, voting rights,
registration rights and a dividend preference. All terms are more fully defined
in the Series A Preferred Stock Purchase Agreement. Each share of Series A
Convertible Preferred Stock is convertible into one share of common stock of
Rightstart.com Inc. Series A Convertible Preferred Stock was excluded in the
calculation of earnings per share because it was anti-dilutive.
NOTE 4: 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 $3,850,000 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 per 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 $3,850,000 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 had no independent value apart
from the exchange transaction.
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
7
<PAGE>
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 which was recorded in the fourth quarter of fiscal
1998. The difference between the fair value of the Series B preferred stock
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 New Securities.
In connection with the above restructuring, effective April 13, 1998, the
holders of the Company's $3,000,000 subordinated notes and $3,000,000
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 14, 1998 was not changed as the
carrying amount of the debt did not exceed the total future cash payments of
$3,000,000 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 $3,000,000
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 an extraordinary gain in fiscal 1998 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.
NOTE 5: New Accounting Pronouncements
During 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and for Hedging Activities," which establishes new standards for
reporting derivative and hedging information. The standard is effective for
periods beginning after June 15, 2000 and will be adopted by the company as of
February 1, 2001. It is not expected that the adoption of this standard will
have an impact on the consolidated financial statements nor require additional
footnote disclosure since the Company does not currently utilize derivative
instruments or participate in structured hedging activities.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Cost of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 is effective for
financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance over accounting for computer software developed or obtained
for internal use including the requirement to capitalize specified costs and
amortization of such costs. The Company adopted SOP 98-1 in the first quarter
of fiscal 1999 and the adoption of this standard did not have a material effect
on the Company's capitalization policy.
8
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NOTE 6: Supplemental Disclosure of Cash Flow Information
Interest paid amounted to $191,000 and $332,000 for the twenty-six weeks
ended July 31, 1999 and August 1, 1998, respectively. Cash paid for income
taxes was $11,000 and $5,000 for the twenty-six weeks ended July 31, 1999 and
August 1, 1998, respectively.
The Company recorded a non-cash transaction related to the vesting of
certain employee stock options which occurred in May 1999.
Rightstart.com issued stock for capitalized software costs totaling
$372,000 in the thirteen weeks ended July 31, 1999.
Changes in assets and liabilities which increased (decreased) cash are as
follows:
<TABLE>
<CAPTION>
Twenty-six weeks ended
----------------------------------
July 31, 1999 August 1, 1998
------------- --------------
<S> <C> <C>
Accounts and other receivables $(106,000) $ 1,000
Merchandise inventories (674,000) 470,000
Prepaid catalog expenses 135,000 (93,000)
Other current assets (284,000) 295,000
Other non-current assets (31,000) (34,000)
Accounts payable and accrued expenses 985,000 (331,000)
Accrued salaries and bonuses 75,000 (166,000)
Advance payments on orders (16,000) 2,000
Deferred rent (20,000) (37,000)
--------- ---------
$ 64,000 $ 107,000
========= =========
</TABLE>
9
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Results of Operations
The consolidated results of operations include the results of The Right
Start, Inc. and its newly formed, majority-owned subsidiary, Rightstart.com,
Inc. Rightstart.com was formed in April 1999 for the purpose of engaging in
electronic commerce over the Internet. Effective May 1, 1999, the Company
contributed its catalog operations to Rightstart.com and in July 1999,
Rightstart.com issued Series A Convertible Preferred Stock to certain investors
representing 33%, on a fully-diluted basis, of Rightstart.com's outstanding
capital stock.
This discussion should be read in conjunction with the information
contained in the consolidated financial statements and notes thereto of the
Company appearing elsewhere in this Form 10-Q.
Statements in this Form 10-Q that are not purely historical are forward-
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. These forward-looking statements with respect to the
financial condition and results of operations of the Company involve risks and
uncertainties which are detailed further in the filings of the Company with the
Securities and Exchange Commission, including, but not limited to, the Company's
Registration Statement on Form S-3 (File No. 333-08157) and its Annual Report on
Form 10-K/A for the year ended January 30, 1999.
Thirteen weeks ended July 31, 1999 compared with August 1, 1998
Net sales for the thirteen weeks ended July 31, 1999 increased 20.6% to
$10.6 million from $8.8 million for the same period last year. For the quarter,
retail net sales increased 21.5% to $9.5 million as compared to $7.8 million
last year, while catalog net sales decreased 10.9% to $.9 million from $1.0
million last year. The Company's new Internet operations contributed $.2
million to net sales for the quarter, reflecting e-commerce sales generated
since the launch of www.rightstart.com on June 29, 1999. Retail sales reflect
sales increases due to same-store sales increases of 13.3% for the quarter and
twelve store openings during and since the second quarter of the prior fiscal
year, offset by one store closing during the first half of the current fiscal
year. The reduction in catalog net sales is due to the Company's decision to
significantly reduce circulation and operate the catalog at a smaller and more
profitable level.
Cost of goods sold increased $.6 million or 13.9%, resulting in a gross
margin of 51% as compared to 48% last year. The improvement in gross margin
resulted from changes in product mix to include significantly more developmental
toys, books, videos and other media, which have higher gross margins, and from
lower markdowns due to higher inventory turns.
Operating expense was $4.6 million in the second quarter of 1999 as
compared to $3.8 million in the second quarter of 1998, representing a 20.2%
increase. Included in consolidated operating costs are Internet operating costs
of $.4 million related to the initial operations and marketing of the Internet
site. Retail operating expense increased 15.7%, primarily due to additional
occupancy and labor costs related to new stores and increases in payroll and
other operating costs in support of the higher retail sales volume.
Additionally, catalog operating expense decreased 29% due to with the decrease
in catalog sales and circulation.
General and administrative expense increased 14.7% to $981,000 during the
second quarter of 1999 from $855,000 during the same period last year. Included
in general and administrative expense is $18,000 related to the Company's
Internet operations. The increase is primarily due to increased travel and
related costs associated with the site selection process for new retail stores
and payroll increases. These costs represent the Company's corporate overhead
expenses which are fixed in nature and do not vary directly with changes in
sales.
Depreciation and amortization expense increased to $399,000 during the
second quarter of 1999 from $326,000 during the same period last year. Included
in the expense is $18,000 related to assets placed in service
10
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for the Company's Internet operations. The remaining 16.9% increase is
primarily due to the expense associated with fixed assets for new stores opened
since last year.
During the second quarter of 1999, the Company recorded $1.8 million of
non-cash compensation charge associated with the vesting of performance options
that had been granted to executive officers of the Company. This expense
results from the increase in the price of the Company's common stock from the
date of grant of the options to the date on which vesting occurred. The
recording of this expense had no net effect on consolidated shareholders'
equity, as an offset to the charge was required to be recorded directly to
shareholders' equity.
Store closing expense in the second quarter of fiscal 1999 represents the
net book value of assets written off related to the store closed during the
quarter.
Interest expense decreased to $112,000 from $122,000 in the second quarter
of the prior year. The 8.2% decrease results from a decrease in total
outstanding borrowings. See Liquidity and Capital Resources.
Twenty-Six Weeks Ended July 31, 1999 Compared With August 1, 1998
Net sales for the twenty-six weeks ended July 31, 1999 increased 19.6% to
$21.2 million from $17.8 million for the same period last year. Retail net
sales increased 22.3% to $18.5 million as compared to $15.1 million last year,
while catalog net sales decreased 4.7% to $2.6 million from $2.7 million last
year. The Company's new Internet operations contributed $.2 million to net
sales for the quarter, reflecting e-commerce sales generated since the launch of
www.rightstart.com on June 29, 1999. Retail sales reflect sales increases due
to same-store sales increases of 19.4% for the first half of the year and twelve
store openings during and since the second quarter of the prior fiscal year.
The reduction in catalog net sales is due to the Company's decision to
significantly reduce circulation and operate the catalog at a smaller and more
profitable level.
Cost of goods sold increased $1.2 million or 12.7%, resulting in a gross
margin of 52% as compared to 49% last year. The improvement in gross margin
resulted from changes in product mix to include significantly more developmental
toys, books, videos and other media, which have higher gross margins, and from
lower markdowns due to higher inventory turns.
Operating expense was $8.8 million in the first half of 1999 as compared to
$8.0 million in the first half of 1998, representing a 9.2% increase. Included
in consolidated operating costs are Internet operating costs of $.4 million
related to the initial operations and marketing of the Internet site. Retail
operating expense increased 8%, primarily due to a 25% increase in payroll and
other operating costs directly related to the increase in net sales, offset by a
6% reduction in occupancy cost due to the shift to street locations and a 25%
reduction in merchandise warehousing costs. Additionally, catalog operating
expense decreased 51% due to the decrease in catalog circulation, catalog
production costs per catalog and those expenses directly related to the decrease
in catalog sales.
General and administrative expense increased 6.4% to $1.9 million during
the first half of 1999 from $1.8 million during the same period last year. The
increase is primarily due to increased travel and related costs associated with
the site selection process for new retail stores and payroll increases. These
costs represent the Company's corporate overhead expenses which are fixed in
nature and do not vary directly with changes in sales.
Depreciation and amortization expense increased to $748,000 during the
first half of 1999 from $674,000 during the same period last year. The 11.0%
increase is primarily due to the expense associated with the fixed asset
additions for the new stores opened since the second quarter of fiscal 1999.
During the second quarter of 1999, the Company recorded $1.8 million of
non-cash compensation charge associated with the vesting of performance options
that had been granted to executive officers of the Company. This expense
results from the increase in the price of the Company's common stock from the
date of grant of the options to the date on which vesting occurred. The
recording of this expense had no net effect on consolidated shareholders'
equity, as an offset to the charge was required to be recorded directly to
shareholders' equity.
Store closing expense in the first half of fiscal 1999 represents the net
book value of assets written off related to the store closed during the second
quarter.
11
<PAGE>
Interest expense decreased to $197,000 from $438,000 in the first half of
the prior year.. This results from a decrease in outstanding borrowings and the
inclusion in 1998 of a non-cash charge of $40,000 related to the amortization
of the discount associated with the $3.85 million of non-interest bearing senior
subordinated notes issued during the first quarter of fiscal 1998. These notes
were exchanged for preferred stock in December 1998.
The Company has a deferred tax asset of $9.9 million, which is reserved by
a valuation allowance of $8.5 million, for a net tax asset of $1.4 million.
Management expects that the Company will generate sufficient taxable income
within the next 15 years to realize the net deferred tax asset. The tax
provision represents state income taxes.
Liquidity and Capital Resources
During the first half of Fiscal 1999, the Company's primary sources of
liquidity were from borrowings under its $13 million senior credit facility (the
"Credit Facility") and the issuance of Series A Convertible Preferred Stock in
Rightstart.com Inc. which provided net proceeds of $13,865,000. The Credit
Facility consists of a $10,000,000 revolving line of credit for working capital
(the "Revolving Line") and a $3,000,000 capital expenditure facility (the "Capex
Line"). Availability under the Revolving Line is subject to a defined borrowing
base. As of July 31, 1999, borrowings of $2,250,000 were outstanding under the
Capex Line. Borrowings of $2,332,000 were outstanding and $815,000 was available
under the Revolving Line at July 31, 1999. 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 assets of The Right Start, Inc. The Company is currently working
with other lenders to negotiate the replacement of the Credit Facility.
Management believes that adequate financing will be available to replace the
Credit Facility in a timely manner.
The Credit Facility, as amended, requires the Company at all times to
maintain net worth (defined to include equity, all classes of stock and
subordinated debt) of at least $8 million. The Credit Facility also requires
the Company's unconsolidated earnings before interest, taxes, depreciation and
amortization (EBITDA) to be at least zero for the twelve months ended July 31,
1999 and $400,000 for the twelve months ended October 31, 1999. In addition,
unconsolidated capital expenditures are limited to $1,750,000 in fiscal year
1999. The Company believes that it will maintain compliance with these
requirements.
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 expects
to continue to incur losses in the near term. Depending on the success of its
business strategy, the Company may continue to incur losses beyond such period.
Losses could negatively affect working capital and the extension of credit by
the Company's suppliers and impact the Company's operations.
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.
12
<PAGE>
Other Matters
Year 2000 Compliance
- --------------------
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 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)
- --------------------------------------------------------------------------------------------------------------------------
System Awareness Assessment Renovation Validation Implementation
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Credit Card Processing x x x x x
- --------------------------------------------------------------------------------------------------------------------------
Inventory Maintenance x x x x
- --------------------------------------------------------------------------------------------------------------------------
Accounting and Reporting x x x x x
- --------------------------------------------------------------------------------------------------------------------------
Point of Sale Transactions x x
- --------------------------------------------------------------------------------------------------------------------------
Internet Transactions x x x x x
- --------------------------------------------------------------------------------------------------------------------------
Non-computerized Systems x x
(none are material to the
Company's operations)
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
In addition to resolving any year 2000 issues on the Company's internal
systems, the Company is working with its third party vendors in implementing the
appropriate solutions. The Company estimates that the maximum, worst-case cost
of addressing its year 2000 issues is approximately $125,000 for hardware and
software.
The Company is currently working with its software vendor for inventory
maintenance systems to complete the installation of the upgraded, year 2000
compliant version of the system. 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 Pronouncements
- -----------------------------
During 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and for Hedging Activities," which establishes new standards for
reporting derivative and hedging information. The standard is effective for
periods beginning after June 15, 2000 and will be adopted by the company as of
February 1, 2001. It is not expected that the adoption of this standard will
have an impact on the consolidated financial statements nor require additional
footnote disclosure since the Company does not currently utilize derivative
instruments or participate in structured hedging activities.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1, "Accounting for the Cost of Computer Software
Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 is effective for
financial statements for years beginning after December 15, 1998. SOP 98-1
provides guidance over accounting for computer software developed or obtained
for internal use including the requirement to capitalize specified costs and
amortization of such costs. The Company adopted SOP 98-1 in the first quarter
of fiscal 1999 and the adoption of this standard did not have a material effect
on the Company's capitalization policy.
13
<PAGE>
Quantitative and Qualitative Disclosures about Market Risks
- -----------------------------------------------------------
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 transaction 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 finanacial
instruments to manage interest rate risk, currency risk or for speculative
purposes and is currently not evaluating the future use of such instruments.
14
<PAGE>
PART II
Item 6. Exhibits and Reports on Form 8-K
The Company filed the following reports on Form 8-K during the second
quarter of 1999.
June 21, 1999 Change in Registrant's Certifying Accountant
June 21, 1999 Change in Registrant's Certifying Accountant
July 9, 1999 Closing of Financing for Internet Subsidiary
There were no other reports on Form 8-K filed during the second quarter of
1999.
The following exhibits of The Right Start, Inc. are included herein.
Exhibit
Number
- ------
27 Financial Data Schedule
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
and thereunto duly authorized.
THE RIGHT START, INC.
Date: September 13, 1999 /s/ JERRY R. WELCH
---------------------------- -------------------------------------
Jerry R. Welch
President and Chief Executive Officer
Date: September 13, 1999 /s/ GINA M. ENGELHARD
---------------------------- -------------------------------------
Gina M. Engelhard
Chief Financial Officer
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-29-2000
<PERIOD-START> JAN-31-1999
<PERIOD-END> JUL-31-1999
<CASH> 14,765
<SECURITIES> 0
<RECEIVABLES> 691
<ALLOWANCES> 0
<INVENTORY> 6,471
<CURRENT-ASSETS> 23,368
<PP&E> 14,099
<DEPRECIATION> 5,167
<TOTAL-ASSETS> 33,818
<CURRENT-LIABILITIES> 9,512
<BONDS> 0
1,932
6,663
<COMMON> 22,374
<OTHER-SE> 4,354
<TOTAL-LIABILITY-AND-EQUITY> 33,818
<SALES> 21,280
<TOTAL-REVENUES> 21,280
<CGS> 10,321
<TOTAL-COSTS> 23,790
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 197
<INCOME-PRETAX> (2,707)
<INCOME-TAX> 29
<INCOME-CONTINUING> (2,736)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,736)
<EPS-BASIC> (0.57)
<EPS-DILUTED> (0.57)
</TABLE>
