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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT to SECTION 13 or 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended April 27, 1996. Commission File Number 0-21910
KIDS MART, INC.
(F/K/A FROST HANNA ACQUISITION GROUP, INC.)
(Exact name of registrant as specified in its charter)
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Florida 65-0406710
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
801 Sentous Avenue, City of Industry, California 91748
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (818) 854-3166
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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:
Title of each class
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Common Stock, par value $0.0001 per share
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. [ ]
There were 4,943,000 shares of common stock, par value $0.0001 per
share for the registrant issued and outstanding as of June 1, 1996.
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KIDS MART, INC.
FORM 10-Q
INDEX
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PAGES
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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements 1
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 1
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 4
ITEM 2. Changes in Securities 4
ITEM 3. Defaults Upon Senior Securities 4
ITEM 4. Submission of Matters to a Vote of Security Holders 4
ITEM 5. Other Information 4
ITEM 6. Exhibits and Reports on Form 8-K 4
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PART I.
ITEM 1. FINANCIAL STATEMENTS
Consolidated statements of income and cash flows for the quarters ended April
27, 1996, and April 29, 1995, and consolidated balance sheets as of April 27,
1996, and January 27, 1996, have not been reported. Kids Mart, Inc. (f/k/a
Frost Hanna Acquisition Group, Inc.) ("the Company" or "FH") is unable to
provide such reports until it resolves issues on the value of assets and
liabilities acquired from Woolworth Corporation ("Woolworth"). The final
resolution of these issues, which are currently in the process of being
finalized, will have a significant impact on the Company's consolidated
financial statements.
PART I.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Kids Mart, Inc. is a value oriented specialty retailer of children's apparel
located in malls and strip centers. It currently operates 296 children's
apparel stores in 20 states under the names Kids Mart (282 stores) and Little
Folks (14 stores).
The Company was formed in April 1993 to serve as a vehicle to effect a merger,
exchange of capital stock, asset acquisition or other similar business
combination with an operating business. In September 1993, the Company
consummated an initial public offering of its equity securities from which it
derived net proceeds of approximately $6.520 million, which was held in escrow
pending the consummation of the following business combination, and was
released to the Company upon consummation of the following merger.
LFS Acquisition Corp. ("LFS"), a Delaware corporation, was formed on May 26,
1995, for the purpose of acquiring the Holtzman's Little Folk Shop, Inc.
("Holtzman's") business from Woolworth Corporation. On May 31, 1995, LFS
acquired (the "Acquisition") all of the outstanding shares of capital stock of
Holtzman's from Woolworth and certain of Holtzman's operating assets and
liabilities from Kinney Shoe Corporation, a wholly-owned subsidiary of Woolworth
("Kinney"). Prior to this transaction, Holtzman's had transferred certain of
its assets and liabilities to Kinney. The preliminary purchase price of the
Acquisition was $22.825 million ($20.975 million to Woolworth plus $1.850
million in transaction fees) consisting of a cash payment of $11.670 million,
$4.304 million of short-term borrowings, and a subordinated note for $5.001
million to Woolworth. This purchase price, excluding transaction fees,
increased from the initial agreed-upon estimated purchase price of $16.670
million due to opening balance sheet adjustments of approximately $4.300 million
(principally inventory, other assets and accrued liabilities). The purchase
price was subject to adjustment based on the final book value of Holtzman's at
May 31, 1995, as defined. In addition, LFS would have been required to pay an
additional purchase price to Woolworth of up to $1.250 million based on excess
cash flow, as defined.
The Acquisition was financed using proceeds from the $5.001 million
subordinated note to Woolworth, $4.420 million of borrowings under the
Company's revolving facility, $4.250 million of short-term bridge loans
advanced by a group of private lenders, as well as Woolworth, and $3.000
million of common stock proceeds from the former shareholders of LFS. LFS also
paid $1.850 million in transaction fees associated with the Acquisition.
On January 3, 1996, the Company consummated a business combination (the
"Business Combination") with LFS pursuant to an Agreement and Plan of Merger
and Reorganization the "Merger Agreement") dated May 31, 1995. The Company's
shareholders approved the Business Combination at a special meeting held on
January 3, 1996. Since the former LFS investors own the controlling interest
of FH's common stock, the Merger will be accounted for as a "reverse
acquisition" whereby LFS is the "accounting acquirer" and FH is the "legal
acquirer".
As a result of the Business Combination, $4.297 million was paid out to satisfy
principal and interest on the bridge loans.
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Pursuant to the Merger Agreement (i) FH Sub Delaware, Inc., a Delaware
corporation and wholly-owned subsidiary of the Company merged with and into LFS
(the "Merger"), as a result of which, LFS became a wholly-owned subsidiary of
the Company, (ii) the Company issued an aggregate of 2,678,000 shares of its
common stock to the owners of all of the issued and outstanding shares of
capital stock of LFS, which constitutes approximately 54% of the outstanding
shares of common stock of the Company without giving effect to the issuance of
1,204,300 shares of the Company's common stock issuable upon the exercise of
certain warrants held by (a) the underwriter of the Company's initial public
offering (110,000 shares) and (b) the initial LFS investors (1,094,300 shares)
and (iii) the Company changed its name to Little Folks Shops, Inc. On January
23, 1996, the Company changed its name to Kids Mart, Inc. Assuming full
exercise of all of the outstanding warrants to purchase shares of the Company's
common stock, the former LFS security holders own approximately 61.4% of the
outstanding shares of the Company's common stock.
During December 1995, the Company filed a lawsuit against Woolworth and Kinney
for fraud, negligent misrepresentation, and breach of contract. LFS contended
that Woolworth's and Kinney's wrongful and/or negligent conduct materially
hampered LFS's cash flow. In particular, LFS believes that before its
acquisition of the Little Folks/Kids Mart business, Woolworth failed to
disclose the significant negative impact that accounting for point-of-sale
markdowns in the period in which the inventory was reduced in price would have
made. Additionally, LFS believes that Woolworth caused serious damage to the
business in the weeks before the acquisition by conducting extended clearance
sales at the stores. Although these sales appear to have been directed
primarily at the liquidation of old inventory, Woolworth damaged the stores'
customer base by failing to inform customers of the special, one-time
opportunity these sales represented. LFS also believes that Woolworth failed
to adjust the acquisition of new inventory to reflect the slower sales of new
merchandise during the sales of older inventories, leaving LFS with excess
inventory at the time it acquired the business. Finally, LFS believes that
Woolworth breached its transitional services agreement. This matter is
addressed more fully under Legal Proceedings in this document.
On May 31, 1996, the Company settled its disputes and pending litigation with
Woolworth and Kinney. Pursuant to the terms of the settlement agreement,
approximately $13.800 million of debt owed or claimed to be owed by LFS
Acquisition Corp., a wholly-owned subsidiary of the Company, to Woolworth was
canceled and approximately $1.670 million deposited in an escrow account was
released to the Company. Also, the Company issued to Woolworth 1,000,000
shares of a new series of the Company's convertible nonvoting preferred stock.
The Company has historically experienced and expects to continue to experience
seasonal fluctuations in its sales and net income. A disproportionate amount
of the Company's sales and net income are realized during the months of
November and December. The Company has also experienced periods of increased
sales activity in early spring and early fall. Furthermore, sales and net
income are generally weakest during the second quarter. Because of the
seasonality of the Company's business, results for any quarter are not
necessarily indicative of results that may be achieved for a full fiscal year.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements are primarily related to the need to purchase
and pay for inventory prior to its sales, the costs associated with computer
system hardware and software installation, and the funding of normal operating
expenses. The Company's cash requirements fluctuate based on the seasonality
of its sales and the required build up of inventory in advance of peak sale
periods.
The Company funds its operations from retail sales; the Company does not offer
its customers credit terms. Additional funding is available under revolving
credit facilities for as much as $20 million at prime plus 2 percent. These
credit facilities are secured by inventory. The line of credit contains various
restrictions concerning the Company's ability to assume additional indebtedness
and specifies limits on capital expenditures. The line of credit also contains
various covenants that require the Company maintain certain minimum levels of
working capital and tangible net worth, as defined, and to maintain certain
minimum financial ratios. During April 1996, the Company amended its revolving
loan agreement with its primary lender.
The Company has experienced difficulty in obtaining adequate credit support from
its factors. As a result, the Company has been required to operate on shortened
payment terms from its vendors, creating significant cash flow constraints. The
Company has been able to obtain merchandise to satisfy planned requirements
through May. However, should the Company be unable to obtain adequate credit
support from suppliers during the Back-to-School and holiday seasons, the
Company's business could be materially and adversely affected.
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The Company has experienced substantial losses since its acquisition of the
Little Folks/Kids Mart business. While the Company believes it has taken
appropriate steps towards profitability, no assurance can be given as to when,
if ever, the Company can become profitable.
Following the date of the recapitalization, the Company has experienced
substantial losses in connection with inventory writedowns which the Company's
management believes were related to the litigation with Woolworth, and cash flow
constraints. As a result of the inventory writedowns, the Company was not in
compliance with its debt covenants as of January 27, 1996. However, the Company
obtained a waiver of this covenant violation. On April 27, 1996, the Company
was in compliance with all of its debt covenants, and approximately $9.516
million was outstanding under this line of credit.
The Company had approximately $0.900 million available under the line of credit
agreement on April 27, 1996. On May 31, 1996, the Company received approximately
$1.670 million from the settlement with Woolworth that enabled the Company to
pay down a significant portion of its outstanding payable commitments. However,
the Company was still experiencing cash flow difficulties. On May 31, 1996, the
Board of Directors adopted a resolution to raise additional equity through a
private placement of the Company's common stock. On June 17, 1996, the Company
amended its loan agreement with its primary lender to include provisions for a
$2.000 million overdraft for the period of June 1996 through February 1997,
contingent on the Company raising at least $2.000 million in common stock equity
on or before September 30, 1996, or having substantially completed the private
placement by that date. The Company must also achieve certain performance
criteria.
The Company believes its liquidity and capital resources are adequate to
continue operations provided the private placement is completed. There is no
assurance that the private placement will be completed. The Company relies
heavily on the Back-to-School sales periods in August and September for cash
flow to support operations. The Company's failure to achieve adequate sales
levels in the Back-to-School and holiday seasons could have a material and
adverse effect on the business.
3
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On December 5, 1995, LFS filed a complaint against Woolworth and
Kinney in Superior Court for the County of Los Angeles. The complaint
alleged fraud, negligent misrepresentation, and breach of contract
against both Woolworth and Kinney. LFS contended that Woolworth's and
Kinney's wrongful and/or negligent conduct materially hampered LFS's
cash flow. In particular, LFS believes that before its acquisition of
the Little Folks/Kids Mart business, Woolworth failed to disclose the
significant negative impact that accounting for point-of-sale
markdowns in the period in which the inventory was reduced in price
would have made. Additionally, LFS believes that Woolworth caused
serious damage to the business in the weeks before the acquisition by
conducting extended clearance sales at the stores. Although these
sales appear to have been directed primarily at the liquidation of old
inventory, Woolworth damaged the stores' customer base by failing to
inform customers of the special, one-time opportunity these sales
represented. LFS also believes that Woolworth failed to adjust the
acquisition of new inventory to reflect the slower sales of new
merchandise during the sales of older inventories, leaving LFS with
excess inventory at the time it acquired the business. Finally, LFS
believes that Woolworth breached its transitional services agreement.
Woolworth and Kinney filed a general denial of all of the material
allegations of the complaint. On January 23, 1996, Woolworth filed
and served a cross-complaint against LFS alleging causes of action for
money paid on behalf of another, account stated, breach of contract,
and unjust enrichment, and seeks recovery of a minimum of $5,591,119
for payroll taxes, sales and use taxes, customs duties and other
taxes, charges and expenses paid by Woolworth on behalf of LFS. LFS
filed a general denial to this cross-complaint on February 23, 1996,
and asserted several affirmative defenses.
On May 31, 1996, the Company announced that it settled its disputes
and pending litigation with Woolworth and Kinney. Pursuant to the
terms of the Settlement Agreement, all of the parties' respective
claims against the other, including all remaining payment obligations
of LFS related to the Acquisition and the related transitional service
agreement, were released and discharged. Woolworth was issued
1,000,000 shares of a new series of the Company's convertible
nonvoting preferred stock. Also, approximately $1.670 million
deposited in an escrow account following the Acquisition was released
to the Company. Further, the parties agreed to extend to October
1996, an agreement with LFS whereby Woolworth performs certain MIS
services for the Company. Management believes this settlement will
have a positive impact on the Company's results of operations for the
fiscal year ended January 25, 1997.
The Company has been notified that certain stores in California have
materials containing asbestos. The asbestos material is generally in
trace quantities, and no remediation is expected to be required on the
understanding that such material is properly secured.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
Form 8-K dated May 31, 1996
99.3 Letter of Deloitte & Touche LLP dated June 17, 1996
4
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SIGNATURE
Pursuant to the requirements 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.
DATE: 17 June, 1996 KIDS MART, INC.
(Registrant)
By: /s/ Bernard Tessler
_________________________________
Bernard Tessler
Chairman, Chief Executive Officer
By: /s/ Robert S. Kelleher
_________________________________
Robert S. Kelleher
Chief Operating Officer,
Chief Financial Officer
5
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[DELOITTE & TOUCHE LLP LETTERHEAD]
June 17, 1996
Kids Mart, Inc.
801 Sentous Avenue
City of Industry, CA 91748
Attention of: Mr. Bernard Tessler, Chief Executive Officer
Dear Sirs:
We are currently in the process of completing our audit of the consolidated
financial statements of Kids Mart, Inc. (the "Company") for the eight-month
period ended January 27, 1996.
The Company, formerly Frost Hanna Acquisition Group, Inc., acquired all the
outstanding shares of capital stock of Holtzman's Little Folk Shop, Inc.
("Holtzman's") from Woolworth Corporation ("Woolworth") and certain of
Holtzman's operating assets and liabilities from Kinney Shoe Corporation, a
wholly owned subsidiary of Woolworth ("Kinney"), on May 31, 1995 (the
"Acquisition"). The preliminary purchase price of the Acquisition was
$22,825,000. This purchase price was subject to adjustment based on the final
book value of Holtzman's at May 31, 1995.
Subsequent to the Acquisition, disagreements have arisen between the Company
and Woolworth regarding the determination of Holtzman's net assets at May 31,
1995. Additionally, the Company filed a complaint against Woolworth and Kinney
in Superior Court for the County of Los Angeles on December 5, 1995 alleging
fraud, negligent misrepresentation and breach of contract against both
Woolworth and Kinney. On January 23, 1996, Woolworth filed and served a
cross-complaint against the Company alleging causes of action for money paid on
behalf of another and seeks recovery of charges and expenses paid by Woolworth
on behalf of the Company.
Additionally, the Company receives information systems, accounting and
administrative services from Woolworth pursuant to the terms of a transition
service agreement. The initial term of the transition service agreement expires
on May 31, 1996. We were informed by management of the Company that on April
30, 1996 Woolworth notified the Company of its decision to terminate the
transition service agreement as of May 31, 1996 and discontinue providing
these support services to the Company. The Company notified
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Woolworth of its interest in extending the transition services agreement until
the Company completes the process of performing these functions internally.
Based on further conversation with management of the Company and Kaye, Scholer,
Fierman, Hays & Handler, LLP. legal counsel for the Company, we understand that
the Company and Woolworth have reached a settlement with Woolworth agreeing to
a significant reduction in the purchase price of the Acquisition and also
agreeing to extend the term of the transition services agreement, thus
discharging all outstanding complaints and cross-complaints between the
Company and Woolworth. We were also informed that the Company has not yet
completed adjusting its consolidated financial statements to reflect the result
of the purchase price adjustment.
Because of the significance that the purchase price adjustment will have on the
consolidated financial statements of the Company, until the Company records the
purchase price adjustment, we are unable to complete our audit of the
consolidated financial statements of Kids Mart Inc. for the eight-month period
ended January 27, 1996.
Very truly yours,
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
