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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 July 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)
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)
(818) 854-3166
(Registrant's telephone number, including area code)
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
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 September 4, 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 2
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 6
ITEM 2. Changes in Securities 6
ITEM 3. Defaults Upon Senior Securities 6
ITEM 4. Submission of Matters to a Vote of Security-Holders 6
ITEM 5. Other Information 6
ITEM 6. Exhibits and Reports on Form 8-K 7
</TABLE>
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PART I.
ITEM 1. FINANCIAL STATEMENTS
Consolidated statements of operations and cash flows for the quarter
and six months ended July 27, 1996, and consolidated balance sheets as of July
27, 1996 and January 27, 1996 have not been reported. Kids Mart, Inc. (the
"Company") is in the process of converting its financial software and
merchandising software systems. Due to the demands of this process, the
financial data and information required to be included herein was not available
as of the date of this filing.
Consolidated statements of operations and cash flows for the quarter
and six months ended July 29, 1995, (the "Disputed Financial Statements") have
not been reported. Preparation and delivery of the Disputed Financial Statements
was an issue in the Company's dispute with Woolworth Corporation and Kinney Shoe
Corporation (collectively, "Woolworth"). See "Item 1. --Legal Proceedings."
Currently, Woolworth and its certified public accountants, KPMG Peat
Marwick, LLP, are preparing the Disputed Financial Statements, which have not
been completed as of the date of this filing. When the Company receives the
Disputed Financial Statements from Woolworth, the Company intends to include
them in an amendment to the Company's Quarterly Report on Form 10-Q for the
quarter ended July 27, 1996.
SUBSEQUENT EVENTS
On September 11, 1996, the Company entered into an agreement with one
of its vendors whereby the vendor agreed to convert $0.65 million of amounts due
from the Company to 433,333 shares of the Company's common stock, par value
$.0001 per share, (the "Common Stock"). In exchange, the Company agreed to use
its best efforts to purchase annually a minimum of $10 million of merchandise
inventories, as defined, from this vendor. Further, the vendor shall have the
right to have its nominee installed as a director to the Company's Board of
Directors within three months of execution of the agreement. Thereafter, unless
the vendor has reduced its investment in the Company by more than 50% the
Company shall nominate said nominee to the Board of Directors to be voted upon
by the shareholders of the Company at each annual meeting.
On September 13, 1996, the Company's Board of Directors approved the
Store Closure Plan (as hereinafter defined) under which the Company immediately
reduced its workforce at its distribution center and administrative offices,
closed approximately 100 stores and reduced its workforce at the stores. The
Company estimates that its lease termination costs, property and equipment
write-off and other closing costs in connection with the Store Closure Plan will
be approximately $5.4 million, which will be recorded as a charge to operations
during the third quarter of fiscal year 1996. The Company has received the
consent of Foothill Capital Corporation ("Foothill"), the Company's principal
lender, to the Store Closure Plan.
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PART I.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
INTRODUCTION
PRIVATE SECURITIES LITIGATION REFORM ACT. This Quarterly Report on Form 10-Q
contains certain forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934 and the Company intends that such forward-looking statements be subject to
the safe harbors created thereby. See "Item 5. Other Information -- Private
Securities Litigation Reform Act."
Kids Mart, Inc. (together with its subsidiaries, the "Company"), a
Florida corporation, is a value oriented chain of children's specialty apparel
stores generally located in strip shopping centers. At July 27, 1996, it
operated 282 children's apparel stores in 20 states under the names Little Folks
(14 stores) and Kids Mart (268 stores). See "-- Recent Developments -- Store
Closure Plan" for information regarding the closure of approximately 100 of the
Company's stores during the third quarter of fiscal year 1996.
The Company (then known as Frost Hanna Acquisition Group, Inc.) 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 $6.6 million. Approximately $5.7 million (representing
approximately 80% of proceeds from the initial public offering, inclusive of
interest earned thereon) was held in escrow, pending the consummation of the
Acquisition (as hereinafter defined) described below and was released to the
Company upon consummation of the Merger (as hereinafter defined) also described
below.
LFS Acquisition Corp. ("LFS") purchased the Little Folks and Kids Mart
business from Woolworth in May 1995 (the "Acquisition"). On January 3, 1996, the
Company merged with LFS.
In January 1996, the Company changed its fiscal year from a calendar
basis ending on December 31 to a 52/53 week fiscal year ending on the Saturday
nearest January 31 and changed its name to Kids Mart, Inc.
RECENT DEVELOPMENTS
CONTINUING LOSSES AND CASH FLOW CONSTRAINTS. The Company has experienced
substantial losses and cash flow constraints since the Acquisition. No assurance
can be given as to when, if ever, the Company will become profitable. See "Item
5. Other Information --Private Securities Litigation Reform Act."
The Company has experienced difficulties 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. Through early May 1996, the Company had been able to obtain
sufficient merchandise to satisfy its requirements. However, during late May,
June, July and August 1996, the Company was unable to obtain adequate credit
support to achieve its planned level of inventory purchases, which severely
impacted its 1996 back-to-school season. The Company relies heavily on inventory
purchased during these months to generate sales during the back-to-school season
in August and September. The Company's failure to achieve adequate sales levels
in the 1996 back-to-school and holiday seasons would have a material adverse
effect on its business.
The Company's recurring losses, cash flow constraints, and anticipated
potential loan covenant violations (see "-- Other Developments") raise
substantial doubt about its ability to continue as a going concern. The
Company's continuation as a going concern is dependent upon its ability to
generate sufficient cash flow to meet its obligations on a timely basis, to
successfully renegotiate its loan covenants, to obtain additional financing or
equity as may be required, and ultimately, to attain profitable operations. In
the event that the Company is not successful in, among other things, arranging
interim and permanent financing such that the Company will be able to purchase
inventory for the 1996 holiday season and thereafter, and attain credit support
from its factors, it will consider alternate means of continuing the business
including further expense reductions, negotiations
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with landlords and vendors to reach agreement on delaying payments, closing
additional stores, as well as any other options available to the Company. In the
event these efforts are unsuccessful, as a last resort, the Company may consider
the possible filing of a petition for reorganization under Chapter 11 of the
Federal bankruptcy laws.
STORE CLOSURE PLAN. In response to the Company's going concern issues,
management implemented a store closure plan (the "Store Closure Plan") during
the third quarter of fiscal year 1996 that includes closing approximately 100
stores (the "Closed Stores") and reducing staff at its distribution center and
administrative offices. The Store Closure Plan will require, during the third
quarter of fiscal year 1996, an estimated charge to operations of approximately
$5.4 million, principally related to store rent liability, closing costs, and
separation pay. The Company has received the consent of Foothill to the Store
Closure Plan.
Management based its decision on which stores to close by reviewing
each store's performance for the twelve-month period from the Acquisition
through May 31, 1996, with respect to sales, gross margins, occupancy costs, and
store contribution. The worst performing stores were identified for closure.
Certain other Closed Stores were determined based on geographic or other market
and cost considerations.
The aggregate rent liability for the Closed Stores is approximately
$13.2 million and the average remaining lease term is approximately 30 months.
In connection with the Store Closure Plan, the Company will undertake to
negotiate with the various landlords the outstanding lease liability of the
Closed Stores. There can be no assurance that such negotiations will be
successful. Failure to reach acceptable agreements with these landlords would
have a material adverse effect on the Company.
In connection with the Store Closure Plan, the Company reduced staff at
its distribution center and administrative offices, with a corresponding
annualized reduction in payroll and benefits expense of approximately $1.4
million.
There are a number of risks associated with the Store Closure Plan,
including, but not limited to, the inability of the Company to successfully
negotiate favorable terms with respect to the lease terminations, the inability
of the Company to generate adequate revenues to cover expenses and generate
profits, and the possibility that due to the staff reductions and store
closings, the Company may not be able to attract or retain qualified personnel.
INTERIM FINANCING. The Company requires immediate financing to purchase
inventory for the 1996 holiday sales season. Failure to achieve adequate sales
levels in the 1996 holiday season would have a material adverse effect on the
Company's business. Management has held discussions with financial advisors and
potential investors with respect to interim financing through short-term
subordinated debt, equity investment, or debt restructuring. The Company has
raised approximately $0.9 million through a sale/leaseback transaction and
conversion of a vendor account payable to shares of Common Stock. See "--Other
Developments." However, the Company has not yet entered into any agreements with
respect to additional interim financing, and accordingly, there can be no
assurance that the Company can obtain such financing, that such financing would
be timely, or that such financing, if obtained, would be sufficient to enable
the Company to continue as a going concern for a reasonable period of time.
PERMANENT FINANCING. The Company also requires substantial long-term investment
so that it can meet its obligations and sustain operations. Toward this end, the
Company has entered into an engagement letter with a financial advisor and
placement agent with respect to a proposed $10 million to $15 million private
placement of the Company's securities. The placement agent's obligations under
the engagement letter are subject to a number of qualifications, including, but
not limited to, the placement agent's successful completion of its due diligence
review and the successful negotiation of a definitive placement agent agreement.
There can be no assurance that such private placement will be consummated, that
it would be on terms favorable to the Company or that it would be sufficient to
enable the Company to continue as a going concern for a reasonable period of
time.
OTHER DEVELOPMENTS. The Company anticipates potential violation of certain of
its loan covenants under its credit facility with Foothill during the remainder
of fiscal year 1996. The Company is currently in negotiations with Foothill to
waive or amend these covenants. There can be no assurance that Foothill will
waive or amend the covenants or that the Company will not violate other
covenants in the future. If the Company does violate any such covenants, there
can be no assurance that Foothill will not declare the Company in default
under the credit facility and seek to exercise its remedies under the credit
facility including foreclosure of the Company's assets.
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The Company has arranged an overdraft facility for up to $2.0 million
with Foothill during the period from June 10, 1996 to February 15, 1997. In
conjunction with arranging the overdraft facility, the Company's credit facility
was amended to require the Company to raise at least $2.0 million in
subordinated debt or common stock equity on or before September 30, 1996, or to
have substantially completed a private placement of the Company's securities by
that date (the "Covenant").
As of September 16, 1996, the Company has raised approximately
$0.9 million of the $2.0 million needed through the transactions discussed
below.
On July 24, 1996, the Company entered into a sale/leaseback transaction
whereby it sold certain equipment to a leasing company for $0.3 million, and
leased it back under an operating lease for 24 months. As consideration for this
transaction, the Company issued a warrant to the leasing company to purchase
50,000 shares of Common Stock at $7 per share.
On September 11, 1996, the Company entered into an agreement pursuant
to which one of its vendors converted $0.65 million of amounts due to the vendor
to 433,333 shares of Common Stock. In exchange, the Company will use its best
efforts to purchase annually a minimum of $10 million of merchandise
inventories, as defined, from this vendor. Further, the vendor shall have the
right to have its nominee installed as a director to the Company's Board of
Directors within three months of execution of the agreement. Thereafter,
unless the vendor has reduced its investment in the Company by more than 50%
the Company shall nominate said nominee to the Board of Directors to be voted
upon by the shareholders of the Company at each annual meeting.
There can be no assurance that the Company will raise the additional
$1.1 million necessary to avoid a violation of the Covenant, that the Company
will not violate other covenants under its credit facility, that if a violation
occurs, that Foothill will not declare the Company in default and seek to
exercise its remedies under the credit facility, including foreclosure of the
Company's assets.
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, lease
payments for store rent, 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; it does not offer its customers credit
terms.
The Company is party to a revolving credit facility with Foothill for
up to $20 million for working capital advances, of which as much as $10 million
can be used for obligations under letters of credit. Aggregate borrowings are
limited to the lesser of $20 million or specified percentages of eligible
merchandise inventories, as defined. All loans made pursuant to the credit
facility are secured by substantially all of the Company's assets and bear
interest at a reference rate plus 2 percent. The credit facility expires on May
31, 1999, and can then be renewed for successive one-year periods unless
terminated by either party pursuant to the terms of such agreement. The credit
facility contains various restrictions concerning the Company's ability to
assume additional indebtedness and specifies limits on capital expenditures. The
credit facility also contains various covenants that require the Company to
maintain certain minimum levels of working capital and tangible net worth, as
defined, and to maintain certain minimum financial ratios, among others. See
"-- Other Developments."
Following the date of the Acquisition, the Company experienced
substantial losses in connection with inventory writedowns recorded prior to the
Settlement Agreement (as hereinafter defined) adjustments (see "Part II. Other
Information. Item 1. Legal Proceedings"), which resulted in a violation of
certain covenants under its credit facility as of January 27, 1996. Subsequent
to January 27, 1996, the Company has experienced losses and cash flow
constraints. However, the Company obtained a waiver of the covenant violation
through April 1996. The Company also anticipates potential violation of certain
other covenants for the remainder of fiscal year 1996. See "-- Other
Developments."
During April and June 1996, the Company amended its revolving credit
facility with Foothill. These amendments modified certain covenants, extended
the term of the agreement from May 31, 1998 to May 31, 1999, and granted the
Company additional borrowings for up to $2.0 million during the period from June
10, 1996 to February 15, 1997. In conjunction with arranging the overdraft
facility, the Company's credit facility was amended to require the Company to
raise at least $2.0 million in subordinated debt or common stock equity on or
before September 30, 1996, or to have substantially completed a private
placement of the Company's securities by that date. To date, the Company has
raised $0.9 million of the $2.0 million needed. There can be no assurance that
the Company will raise the additional $1.1 million necessary to avoid a
violation of the Covenant, that the Company will not violate other covenants
under its credit facility, or that if a violation occurs, that Foothill will not
declare the Company in default and seek to exercise
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its remedies under the credit facility, including foreclosure of the Company's
assets. The Company must also achieve certain performance criteria. The Company
issued to Foothill warrants to purchase 100,000 shares of Common Stock at $6
per share as consideration for these amendments.
As of July 27, 1996, approximately $7.9 million was outstanding at
10.25% under the credit facility. There was no credit available as of that date.
Further, the Company had borrowed $1.5 million and had $0.5 million available
under its overdraft facility.
The Company has experienced difficulties 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. Through early May 1996, the Company had been able to obtain
sufficient merchandise to satisfy its requirements. However, during late
May, June, July and August 1996, the Company was unable to obtain adequate
credit support to achieve its planned level of inventory purchases, which
severely impacted its 1996 back-to-school season. The Company relies heavily on
inventory purchased during these months to generate sales during the
back-to-school season in August and September. The Company's failure to achieve
adequate sales levels in the 1996 back-to-school and holiday seasons would have
a material adverse effect on its business.
The Company's recurring losses, cash flow constraints, and anticipated
potential loan covenant violations (see "Recent Developments --Other
Developments") raise substantial doubt about its ability to continue as a going
concern. The Company's continuation as a going concern is dependent upon its
ability to generate sufficient cash flow to meet its obligations on a timely
basis, to successfully renegotiate its loan covenants, to obtain additional
financing or equity as may be required, and ultimately, to attain profitable
operations. In the event that the Company is not successful in, among other
things, arranging interim and permanent financing such that the Company will be
able to purchase inventory for the 1996 holiday season and thereafter, and
attain credit support from its factors, it will consider alternate means of
continuing the business including further expense reductions, negotiations with
landlords and vendors to reach agreement on delaying payments, closing
additional stores, as well as any other options available to the Company. In the
event these efforts are unsuccessful, as a last resort, the Company may consider
the possible filing of a petition for reorganization under Chapter 11 of the
Federal bankruptcy laws.
The Company requires immediate financing to purchase inventory for the
1996 holiday sales season. Failure to achieve adequate sales levels in the 1996
holiday season would have a material adverse effect on the Company's business.
Management has held discussions with financial advisors and potential investors
with respect to interim financing through short-term subordinated debt, equity
investment, or debt restructuring. The Company has raised approximately $0.9
million through a sale/leaseback transaction and conversion of a vendor account
payable to shares of Common Stock. See "Recent Developments --Other
Developments." However, the Company has not yet entered into any agreements with
respect to additional interim financing, and accordingly, there can be no
assurance that the Company can obtain such financing, that such financing would
be timely, or that such financing, if obtained, would be sufficient to enable
the Company to continue as a going concern for a reasonable period of time.
The Company also requires substantial long-term investment so that it
can meet its obligations and sustain operations. Toward this end, the Company
has entered into an engagement letter with a financial advisor and placement
agent with respect to a proposed $10 million to $15 million private placement of
the Company's securities. The placement agent's obligations under the engagement
letter are subject to a number of qualifications, including, but not limited to,
the placement agent's successful completion of its due diligence review and the
successful negotiation of a definitive placement agent agreement. There can be
no assurance that such private placement will be consummated, that it would be
on terms favorable to the Company or that it would be sufficient to enable the
Company to continue as a going concern for a reasonable period of time.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On December 5, 1995, LFS filed a complaint against Woolworth
in Superior Court for the County of Los Angeles. The complaint alleged
fraud, negligent misrepresentation, and breach of contract in
connection with the Acquisition. LFS contended that before the
Acquisition, Woolworth conducted extended clearance sales which damaged
the Company's consumer base, failed to disclose to LFS the financial
impact resulting from inventory markdowns and purchased excess
inventory which LFS acquired in the Acquisition. In addition, LFS
claimed that Woolworth breached the Service Agreement. Woolworth
filed a general denial of all of the material allegations of the
complaint and served a cross-complaint against LFS.
On May 30, 1996, the Company and Woolworth entered into a
Mutual Release and Settlement Agreement (the "Settlement Agreement").
Pursuant to the Settlement Agreement, Woolworth agreed to release to
the Company $1.7 million placed in escrow at the closing of the
Acquisition, cancel the $9.3 million of Company debt and liabilities
incurred in connection with the Acquisition, and also cancel $4.4
million of other amounts advanced by Woolworth on behalf of the Company
during the eight months ended January 27, 1996. In exchange, the
Company issued to Woolworth one million shares of Series A convertible
nonvoting preferred stock. These shares were valued at $3.5 million,
representing their fair market value at the date of issuance. The
Company has reflected the impact of the Settlement Agreement on its
consolidated financial statements as of May 31, 1995, the date of the
Acquisition.
Woolworth has refused to pay the Company $0.5 million for
amounts collected on behalf of the Company under the terms of the
Service Agreement. In its consolidated balance sheet as of January 27,
1996, the Company reported a receivable from Woolworth for $0.5
million, which it has deducted from payments owed to Woolworth under
the terms of the Service Agreement. If it is determined that the
Company must release Woolworth from the $0.5 million liability, there
could be a material adverse impact on the Company's results of
operations and cash flows. The Company has not recorded a loss
provision in its consolidated financial statements for the eight months
ended January 27, 1996, based upon management's belief that the
possibility of such loss is remote.
The Company has been notified that certain stores that it
leases 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
PRIVATE SECURITIES LITIGATION REFORM ACT. The Private Securities
Litigation Reform Act of 1995 provides a "safe harbor" for
forward-looking statements. Certain information included in other parts
of this Form 10-Q and other materials filed or to be filed by the
Company with the Securities and Exchange Commission contains statements
that are forward-looking, such as statements relating to the Company's
Store Closure Plan, statements relating to the Company's need for
additional financing and statements regarding the Company's anticipated
potential loan covenant violations, among others. Such forward-looking
information involves important risks and uncertainties that could
significantly affect anticipated results in the future, and
accordingly, such results may differ from those expressed in any
forward-looking statements made by or on behalf of the Company. These
risks and uncertainties
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include, but are not limited to, the risk of continuing losses and cash
flow constraints despite the Company's efforts to improve operations,
including the Store Closure Plan, the inability to obtain interim
financing or permanent financing such that the Company will be able to
purchase inventory for the 1996 holiday season and thereafter, and
attain credit support from its factors, failure to negotiate acceptable
payment terms with vendors and landlords, and failure to negotiate
waivers or amendments to loan covenants.
Item 6. Exhibits and Reports on Form 8-K
The Company filed a current report on Form 8-K, dated May 31, 1996,
relating to the settlement of its litigation against Woolworth
Corporation and Kinney Shoe Corporation.
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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: 16 September, 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
8
