<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
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)
(Registrant's telephone number, including area code) (818) 854-3166
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 of the
registrant issued and outstanding as of October 22, 1996.
<PAGE> 2
The Registrant hereby amends its Quarterly Report on Form 10-Q for the
fiscal quarter ended July 27, 1996 in its entirety as follows:
KIDS MART, INC.
FORM 10-Q/A
INDEX
<TABLE>
<CAPTION>
PAGES
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements 1
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 13
ITEM 2. Changes in Securities 13
ITEM 3. Defaults Upon Senior Securities 13
ITEM 4. Submission of Matters to a Vote of Security-Holders 13
ITEM 5. Other Information 14
ITEM 6. Exhibits and Reports on Form 8-K 14
</TABLE>
<PAGE> 3
PART I
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
KIDS MART, INC. JULY 27, JANUARY 27,
CONSOLIDATED BALANCE SHEETS 1996 1996
- ----------------------------------------------------------------------------------------
(In thousands, except share and par value amounts)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash $1,292 $502
Receivable from Woolworth Corporation - 1,670
Merchandise inventories (Note 3) 12,087 17,144
Prepaid expenses and other current assets 1,395 1,888
------- -------
Total current assets 14,774 21,204
Property and equipment, net 6,616 6,106
Other assets, net 255 299
------- -------
$21,645 $27,609
======= =======
LIABILITIES AND STOCKHOLDERS' (DEFICIENCY) EQUITY
CURRENT LIABILITIES:
Borrowings under credit facility $9,422 $8,849
Accounts payable 9,215 5,562
Accrued expenses and other current
liabilities (Note 4) 2,889 4,546
Deferred revenue 1,131 1,237
------- -------
Total current liabilities 22,657 20,194
Deferred rent 408 278
Redeemable common stock 50 50
------- -------
Total liabilities 23,115 20,522
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' (DEFICIENCY) EQUITY
Preferred stock, par value $.0001 per share;
100,000,000 shares authorized; 1,000,000
issued and outstanding; liquidation preference
of $10,000,000
Common stock, $.0001 par value; 100,000,000 shares
authorized; 4,943,000 shares issued
and outstanding
Additional paid-in capital 12,783 12,783
Accumulated deficit (14,253) (5,696)
------- -------
Total stockholders' (deficiency) equity (1,470) 7,087
------- -------
$21,645 $27,609
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE> 4
KIDS MART, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
QUARTER SIX MONTHS
ENDED ENDED
------------ ------------
JULY 27, JULY 27,
1996 1996
------------ ------------
<S> <C> <C>
Net sales $20,967 $47,370
Cost of sales 13,720 29,662
------- -------
Gross profit 7,247 17,708
Selling, general and administrative
expenses 12,263 24,463
Depreciation and amortization 468 1,014
------- -------
Loss from operations (5,484) (7,769)
Interest expense 370 788
------- -------
NET LOSS ($5,854) ($8,557)
======= =======
PER SHARE DATA:
Average shares outstanding 4,943 4,943
======= =======
Net loss per common share ($1.18) ($1.73)
======= =======
Dividends per common share None None
======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE> 5
KIDS MART, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JULY 27, 1996
<TABLE>
<CAPTION>
-------------------------------------------------------------------
(In thousands)
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(8,557)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 1,014
Merchandise inventory markdown reserve (983)
Changes in operating assets and liabilities:
Receivable from Woolworth Corporation 1,670
Merchandise inventories 6,040
Prepaid expenses and other current assets 493
Other assets 12
Accounts payable 3,653
Accrued expenses and other current liabilities (1,657)
Deferred revenue (106)
Deferred rent 130
------
Net cash provided by operating activities 1,709
------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,780)
Proceeds from sale of property and equipment 288
------
Net cash used in investing activities (1,492)
------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under credit facility 573
------
Net cash provided by financing activities 573
------
NET INCREASE IN CASH 790
------
CASH, BEGINNING OF PERIOD 502
------
CASH, END OF PERIOD $1,292
======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid $ 673
Income taxes paid $ --
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 6
KIDS MART, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER AND SIX MONTHS ENDED JULY 27, 1996
(UNAUDITED, EXCEPT FOR INFORMATION AS OF AND FOR THE EIGHT MONTHS ENDED
JANUARY 27, 1996)
- -----------------------------------------------------------------------
(Dollar amounts in thousands, except per share amounts)
1. BASIS OF PRESENTATION
References to the "Company" are to Kids Mart, Inc. on a consolidated
basis. All significant intercompany transactions and balances have
been eliminated. See notes to the audited consolidated financial
statements presented in the Company's Annual Report on Form 10-K as of
and for the eight months ended January 27, 1996.
The accompanying consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets
and the satisfaction of liabilities in the normal course of business.
As shown in the consolidated financial statements, during the quarter
and six months ended July 27, 1996, the Company incurred net losses of
$5,854 and $8,557, respectively; its current liabilities exceeded its
current assets by $7,883 and it had a stockholders deficiency of
$1,470 as of July 27, 1996. Additionally, subsequent to July 27,
1996, the Company continued to experience operating losses and is in
violation of certain covenants (see Note 5). These factors, among
others, may indicate that the Company will be unable to continue
as a going concern for a reasonable period of time.
In response to these conditions, the Company has taken steps to reduce
expenses and increase liquidity. The Company has, among other things,
increased the percentage of higher margin private label merchandise and
closed 37 stores during the eight months ended January 27, 1996. During
the quarter ended, July 27, 1996, the Company closed 17 additional
stores, reduced its workforce, and renegotiated certain of its store
leases. In addition, subsequent to July 27, 1996, the Company entered
into an agreement with a vendor to convert amounts payable to this
vendor to common stock (see Note 5), implemented a store closure plan
(the "Store Closure Plan") whereby it closed 97 stores (see Note 5), is
renegotiating its loan covenants with its lender, and is exploring
various interim and permanent financing opportunities with several
financial advisors.
The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset
amounts or the amounts and classifications of liabilities that might
be necessary should the Company be unable 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 negotiate its loan
covenants with its lender and payment terms with its vendors and
landlords, to obtain additional financing or equity as may be
required, and ultimately, to attain profitable operations. Management
is continuing its efforts to obtain additional funds so that the
Company can meet its obligations and sustain operations (see Note 5).
2. SUMMARY OF ACCOUNTING POLICIES
The Company is a retailer of children's apparel. It operated a chain
of 282 specialty children's apparel stores in 20 states as of July 27,
1996. See Note 5 for information regarding the closure of 97 of the
Company's stores during the third quarter of fiscal year 1996.
The Company's fiscal year is the 52/53-week period ending on the
Saturday nearest January 31.
The Company's accounting and reporting policies conform to generally
accepted accounting principles prescribed for commercial and
industrial companies, and predominant retail industry practice. The
interim period consolidated financial statements are unaudited. The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues
and expenses during the period. Actual results could differ from
those estimates. It is the opinion of Company management that all
adjustments consisting of normal recurring accruals necessary for a
fair presentation of the results of operations have been reflected
therein.
4
<PAGE> 7
KIDS MART, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER AND SIX MONTHS ENDED JULY 27, 1996
(UNAUDITED, EXCEPT FOR INFORMATION AS OF AND FOR THE EIGHT MONTHS ENDED
JANUARY 27, 1996)
- -----------------------------------------------------------------------
(Dollar amounts in thousands, except per share amounts)
Consolidated statements of operations for the quarter and six months
ended July 29, 1995, and a consolidated statement of cash flows for
the 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 described in "Part II. Item 1. Legal Proceedings."
Currently, Woolworth is preparing and its certified public
accountants, KPMG Peat Marwick, LLP, are auditing 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.
Prior period amounts have been restated to conform to current
period presentation.
3. MERCHANDISE INVENTORIES
Merchandise inventories included markdown reserves of $181 and $1,164
as of July 27, 1996, and January 27, 1996, respectively.
4. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consisted of the
following as of the dates indicated:
<TABLE>
<CAPTION>
July 27, January 27,
1996 1996
----------- -----------
(In thousands)
<S> <C> <C>
Accrued payroll and related expenses $535 $1,114
Accrued advertising expenses 768 810
Accrued sales tax 1,092 603
Other accrued expenses 494 2,019
----------- ----------
Total $2,889 $4,546
=========== ==========
</TABLE>
5. SUBSEQUENT EVENTS
On September 11, 1996, the Company entered into an agreement with a
vendor whereby the vendor agreed to convert $650 of amounts due from
the Company to 433,333 shares of common stock. In exchange, the
Company agreed to use its best efforts to purchase annually a minimum
of $10,000 of merchandise inventories, as defined, from the vendor.
On September 17, 1996, the Company implemented the Store Closure Plan
under which the Company reduced its workforce at its distribution
center and administrative offices and closed 97 stores. The Company
recorded $5,366 for lease termination costs, property and equipment
write-off and other closing costs in connection with the Store
Closure Plan as a charge to operations during the third quarter
ending October 26, 1996.
5
<PAGE> 8
KIDS MART, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER AND SIX MONTHS ENDED JULY 27, 1996
(UNAUDITED, EXCEPT FOR INFORMATION AS OF AND FOR THE EIGHT MONTHS ENDED
JANUARY 27, 1996)
- -----------------------------------------------------------------------
(Dollar amounts in thousands, except per share amounts)
On September 30, 1996, the Company was in violation of its amended
credit facility, for failing to have arranged $2,000 of interim
financing or substantially completed a private placement of the
Company's securities by that date. Subsequent to September 30, 1996,
the Company is in violation of certain other covenants. The Company's
lender has not declared the Company in default, and has cooperated
with management while the Company continues to pursue interim and
permanent financing.
* * * * *
6
<PAGE> 9
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 "Part II. Item 5. Other Information
- -- Private Securities Litigation Reform Act."
OVERVIEW. The following discussion presents information about the financial
condition, liquidity and capital resources, and results of operations of the
Company as of and for the quarter and six months ended July 27, 1996. This
information should be read in conjunction with the audited consolidated
financial statements of the Company and the notes thereto as of and for the
eight months ended January 27, 1996.
The Company reported net losses of $5.9 million and $8.6 million on net sales
of $21.0 million and $47.4 million for the quarter and six months ended July
27, 1996, respectively. The Company had a working capital deficiency of $7.9
million and a stockholders' deficiency of $1.5 million, respectively, as of
July 27, 1996. The Company is in violation of certain of its loan covenants
under its credit facility with Foothill Capital Corporation ("Foothill"), the
Company's principal lender, and anticipates violation of other covenants for
the remainder of fiscal year 1996. These conditions raise substantial doubt
about the Company's ability to continue as a going concern for a reasonable
period of time.
In response to the Company's going concern issues, management implemented the
Store Closure Plan during the third quarter of fiscal year 1996 whereby it
closed 97 stores (the "Closed Stores") and reduced staff at its distribution
center and administrative offices. The Store Closure Plan required, during the
third quarter of fiscal year 1996, a charge to operations of approximately $5.4
million, principally related to store rent liability, closing costs, and
separation pay. The Company received the consent of Foothill to the Store
Closure Plan.
RECENT DEVELOPMENTS
CONTINUING LOSSES AND CASH FLOW CONSTRAINTS. The Company has experienced
substantial losses and cash flow constraints since it purchased the Little
Folks and Kids Mart business from Woolworth Corporation and Kinney Shoe
Corporation (collectively, "Woolworth") in May 1995, (the "Acquisition"). No
assurance can be given as to when, if ever, the Company will become profitable.
7
<PAGE> 10
The Company has experienced difficulties in obtaining adequate credit support
from its vendors. As a result, the Company has been required to operate on
shortened payment terms, creating significant cash flow constraints. Through
early May 1996, the Company had been able to obtain sufficient merchandise to
satisfy its requirements. However from late May through the date of this
filing, the Company has been 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's failure to achieve adequate sales levels
in the 1996 holiday season would have a material adverse effect on its business.
The Company's recurring losses, cash flow constraints, and loan covenant
violations 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 immediate interim financing such that it will be able
to purchase inventory for the 1996 holiday season, arranging permanent
financing for inventory purchases thereafter, and attaining credit support from
its vendors, 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 the Company is
unsuccessful in obtaining immediate interim financing for the 1996 holiday
season, or if such financing is obtained but the required level of permanent
financing is not obtained, the Company will consider the filing of a petition
for reorganization under Chapter 11 of the Federal bankruptcy laws.
See "--Liquidity and Capital Resources."
8
<PAGE> 11
LITIGATION. Due to, among other things, significant cash flow constraints
and implementation of the Store Closure Plan, the Company has been unable to
make required payments to certain vendors and landlords. In response, certain
of these vendors and landlords, have sued the Company for such past due
amounts. The Company does not dispute the nature of these claims and has
recorded the liabilities in its consolidated financial statements. In many
of the actions, the Company has held discussions with the vendors, landlords,
or their attorneys to reach a mutually satisfactory resolution. While
management believes that none of these claims, individually, is material,
taken as a whole, the successful prosecution of these claims would have a
material adverse effect on the Company's cash flow.
TRANSITIONAL SERVICES. In the past, Woolworth has provided the Company with
information systems and accounting and administrative services pursuant to a
transition service agreement (the "Service Agreement"). The term of the
Service Agreement was originally through September 28, 1996 but automatically
extended for successive one-month periods until terminated by either party
upon 30 days' written notice. Upon due notice by Woolworth, the agreement
was terminated on October 26, 1996. Thereupon, the Company converted to its
own information systems for merchandising and financial accounting. The
Company and Woolworth are currently working on the final conversion issues.
In accordance with the Service Agreement, Woolworth will continue to provide
to the Company through the first quarter of fiscal year 1997, certain
information services with respect to store point-of-sale systems and price
data.
FINANCIAL CONDITION
The Company's working capital deficiency was $7.9 million as of July 27, 1996,
as compared to working capital of $1.0 million as of January 27, 1996. Its
current ratio and debt-to-equity ratio were 0.65 and (15.72), respectively, at
July 27, 1996; and 1.05 and 2.90, respectively, at January 27, 1996.
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 sheets as of July 27, 1996, and 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 would 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 quarter and six
months ended July 27, 1996, based upon management's belief that the possibility
of such loss is remote.
Merchandise inventories decreased approximately $5.0 million or 29.5% from
$17.1 million at January 27, 1996, to $12.1 million at July 27, 1996.
The decrease in inventory was greater than the amount intended to improve
inventory turnover and was primarily the result of the Company's inability
to achieve expected inventory receipts due to cash flow constraints.
Pursuant to the Store Closure Plan, the Company transferred the remaining
inventory from the Closed Stores to the remaining open stores. Prior to the
Store Closure Plan, average store retail inventory was approximately $78.3
thousand, which was $25.7 thousand below planned retail store inventory for
September 1996. The inventory consolidation brought the average retail store
inventory up to approximately $112.1 thousand. However, there can
9
<PAGE> 12
be no assurance that the increased inventory levels will improve the Company's
sales and operating results or that the Company's inventory levels will not
drop below acceptable levels in the future.
Property and equipment increased $0.5 million, net since January 27, 1996. The
Company purchased approximately $1.8 million of property and equipment,
including $1.0 million for software and computer equipment, $0.1 million for
store leaseholds and equipment, and $0.7 million for office equipment. In July
1996, the Company entered into a sale/leaseback transaction whereby it sold
certain leasing equipment to a leasing company for $0.3 million. See "--
Recent Developments --Other Developments."
Accounts payable increased to $9.2 million at July 27, 1996, from $5.6 million
at January 27, 1996. This increase was partly offset by a $1.7 million
decrease in accrued expenses. Overall, accounts payable and accrued expenses
increased approximately 19.7% since year end largely due to cash flow
constraints. The Company is holding discussions with vendors to apprise them
of the Company's financing strategies and to arrange payment terms to sustain
operations while the Company arranges financing.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash requirements are primarily related to the need to purchase
and pay for inventory prior to its sale, lease payments for store rent, the
costs associated with the 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. As of
the date of this filing, the Company is in violation of certain of these
covenants.
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. The Company issued to Foothill warrants to purchase
100,000 shares of Common Stock at $6 per share as consideration for these
amendments. 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. Although the Company has raised
$0.9 million of the $2.0 million needed through the transactions discussed
below, the Company is currently in violation of this covenant.
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.
Foothill has cooperated with the Company to maintain the overdraft facility
while management continues to pursue interim and permanent financing. However,
there can be no assurance that Foothill will waive or amend the various
covenants in which the Company is currently in violation, or that Foothill will
not declare the Company in default under the credit facility and seek to
exercise its remedies thereunder, including foreclosure of the Company's assets.
10
<PAGE> 13
At July 27, 1996, the Company had drawn down approximately $9.4 million 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. Subsequent to July 27, 1996, the
Company is in violation of certain covenants under its credit facility. The
Company also anticipates other covenant violations during the remainder of
fiscal year 1996. At October 22, 1996, the Company had $12.5 million
outstanding under the credit facility, including $0.4 million of borrowings in
excess of its $2.0 million overdraft facility.
The Company has experienced difficulties in obtaining adequate credit support
from its vendors. As a result, the Company has been required to operate on
shortened payment terms, creating significant cash flow constraints. Through
early May 1996, the Company had been able to obtain sufficient merchandise to
satisfy its requirements. However from late May through the date of this filing,
the Company has been 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's failure to achieve adequate sales levels in
the 1996 holiday season would have a material adverse effect on its business.
In order to purchase inventory for the 1996 holiday season and thereafter, the
Company requires immediate financing. Management has held discussions with
financial advisors and potential investors with respect to immediate interim
financing through short-term subordinated debt, equity investment, or debt
restructuring. However, the Company has not yet consummated any transactions
with respect to such 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.
In the event that the Company is not successful in, among other things,
arranging immediate interim financing such that it will be able to purchase
inventory for the 1996 holiday season, arranging permanent financing for
inventory purchases thereafter, and attaining credit support from its vendors,
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 the Company is unsuccessful in obtaining
immediate interim financing for the 1996 holiday season, or if such financing is
obtained, but the required level of permanent financing is not obtained, the
Company will consider the filing of a petition for reorganization under Chapter
11 of the Federal bankruptcy laws.
RESULTS OF OPERATIONS
The Company has historically experienced and expects to continue to experience
seasonal fluctuations in its sales and operating results. A disproportionate
amount of the Company's sales and operating results 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 operating results 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.
The Company reported net losses of $5.9 million and $8.6 million on net sales
of $21.0 million and $47.4 million for the quarter and six months ended July
27, 1996, respectively. The Company operated 282 stores at July 27, 1996.
After giving effect to the Store Closure Plan and other store closures,
the Company operates 182 stores.
11
<PAGE> 14
Second quarter net sales decreased $5.4 million or 20.6% from net sales
reported for the first quarter ended April 27, 1996. The decrease reflected
inventory shortages during late May, June and July, as well as the usual
seasonal decrease during the second quarter of the Company's fiscal year.
Gross profit is the difference between sales, net of discounts, and merchandise
inventory at cost, including inventory markdowns. Gross profit margin is gross
profit expressed as a percentage of net sales. Gross profit was $7.2 million
and $17.7 million, and gross profit margin was 34.6% and 37.4% for the quarter
and six months ended July 27, 1996, respectively. Gross profit decreased
$3.2 million and gross profit margin decreased 5.0% for the second quarter
ended July 27, 1996 from the first quarter ended April 27, 1996. The decrease
in gross profit and gross profit margin resulted from lower sales and inventory
shortages. See "--Financial Condition."
Selling, general and administrative expenses were $12.3 million and $24.5
million for the quarter and six months ended July 27, 1996, respectively.
Selling, general and administrative expenses did not decrease from the
first quarter ended April 27, 1996. The Company closed 17 stores and reduced
its workforce in conjunction with the expiration of the store leases on
July 27, 1996.
Depreciation and amortization were $0.5 million and $1.0 million for the
quarter and six months ended July 27, 1996.
Interest expense was $0.4 million and $0.8 million for the quarter and six
months ended July 27, 1996.
In response to the Company's going concern issues, management implemented the
Store Closure Plan during the third quarter of fiscal year 1996 whereby it
closed 97 stores and reduced staff at its distribution center and
administrative offices. The Store Closure Plan required, during the third
quarter of fiscal year 1996, a charge to operations of approximately $5.4
million, principally related to store rent liability, closing costs, and
separation pay. The Company received the consent of Foothill to the Store
Closure Plan. See "--Recent Developments--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 29 months. In
connection with the Store Closure Plan, the Company has begun negotiations with
the various landlords to settle 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's business.
The Company reduced staff at its distribution center and administrative
offices, resulting in an 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.
12
<PAGE> 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On December 5, 1995, LFS, the Company's predecessor-in-interest, 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 sheets as of July 27, 1996 and
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 quarter and
six months ended July 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
13
<PAGE> 16
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 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.
Exhibit 27 Financial Data Schedule.
14
<PAGE> 17
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: 30 October, 1996 KIDS MART, INC.
(Registrant)
By: /s/ BERNARD TESSLER
--------------------
Bernard Tessler
Chairman and Chief
Executive Officer
By: /s/ ROBERT S. KELLEHER
-----------------------
Robert S. Kelleher
Vice President, Chief
Operating Officer,
and Chief Financial Officer
15
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM CONSOLIDATED
BALANCE SHEET AND STATEMENT OF OPERATIONS ON FORM 10-Q AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> FEB-3-1997
<PERIOD-START> JAN-28-1996
<PERIOD-END> JUL-27-1996
<CASH> 1,292
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 12,087
<CURRENT-ASSETS> 14,774
<PP&E> 9,071
<DEPRECIATION> 2,455
<TOTAL-ASSETS> 21,645
<CURRENT-LIABILITIES> 22,657
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> (1,470)
<TOTAL-LIABILITY-AND-EQUITY> 21,645
<SALES> 47,370
<TOTAL-REVENUES> 47,370
<CGS> 29,662
<TOTAL-COSTS> 29,662
<OTHER-EXPENSES> 25,477
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 788
<INCOME-PRETAX> (8,557)
<INCOME-TAX> 0
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