<PAGE> 1
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 October 26, 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 December 31, 1996.
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KIDS MART, INC.
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGES
<S> <C> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements 3
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results
of Operations 10
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 16
ITEM 2. Changes in Securities 16
ITEM 3. Defaults Upon Senior Securities 16
ITEM 4. Submission of Matters to a Vote of
Security-Holders 17
ITEM 5. Other Information 17
ITEM 6. Exhibits and Reports on Form 8-K 17
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
KIDS MART, INC. OCTOBER 26, JANUARY 27,
CONSOLIDATED BALANCE SHEETS 1996 1996
- --------------------------------------------------------------------------------
(In thousands, except share (unaudited)
and par value amounts)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 616 $ 502
Receivable from Woolworth Corporation -- 1,670
Merchandise inventories (Note 3) 7,220 17,144
Prepaid expenses and other
current assets 957 1,888
-------- --------
Total current assets 8,793 21,204
Property and equipment, net 4,968 6,106
Other assets, net 104 299
-------- --------
$ 13,865 $ 27,609
======== ========
LIABILITIES AND STOCKHOLDERS'
(DEFICIENCY) EQUITY
CURRENT LIABILITIES
Borrowings under credit facility $ 7,326 $ 8,849
Accounts payable 14,768 5,562
Reserve for Store Closure Plan (Note 4) 3,921 --
Accrued expenses and other current
liabilities (Note 5) 2,438 4,546
Deferred revenue 953 1,237
-------- --------
Total current liabilities 29,406 20,194
Deferred rent 339 278
Redeemable common stock 50 50
-------- --------
Total liabilities 29,795 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 (28,713) (5,696)
-------- --------
Total stockholders'
(deficiency) equity (15,930) 7,087
-------- --------
$ 13,865 $ 27,609
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
3
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KIDS MART, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
QUARTER NINE MONTHS
ENDED ENDED
---------- ----------
OCTOBER 26, OCTOBER 26,
1996 1996
---------- ----------
<S> <C> <C>
Net sales $ 16,291 $ 63,661
Cost of sales 12,532 42,194
---------- ----------
Gross profit 3,759 21,467
Selling, general and
administrative expenses 11,882 36,351
Provision for Store
Closure Plan (Note 4) 5,247 5,247
Depreciation and amortization 371 1,385
---------- ----------
Loss from operations (13,741) (21,516)
Interest expense 713 1,501
---------- ----------
NET LOSS $ (14,454) $ (23,017)
========== ==========
PER SHARE DATA:
Average shares outstanding 4,943 4,943
========== ==========
Net loss per common share $ (2.92) $ (4.66)
========== ==========
Dividends per common share None None
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
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KIDS MART, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
NINE MONTHS ENDED OCTOBER 26, 1996
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<TABLE>
<CAPTION>
(In thousands) (unaudited)
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (23,017)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 1,681
Provision for Store Closure Plan Reserve 3,921
Loss on retirement of Closed Store
property and equipment 1,227
Loss on retirement of property and equipment 109
Changes in operating assets and liabilities:
Woolworth receivable 1,670
Merchandise inventories 9,924
Prepaid expenses and other current assets 931
Other assets (104)
Accounts payable 9,206
Accrued expenses and other current liabilities (2,108)
Deferred revenue (284)
Deferred rent 61
-----------
Net cash provided by operating activities 3,216
-----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,867)
Proceeds from sale of property and equipment 288
-----------
Net cash used in investing activities (1,579)
-----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on credit facility (1,523)
-----------
Net cash used in financing activities (1,523)
-----------
NET INCREASE IN CASH 114
-----------
CASH, BEGINNING OF PERIOD 502
-----------
CASH, END OF PERIOD $ 616
===========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Interest paid $ 1,074
Income taxes paid $ --
</TABLE>
See accompanying notes to consolidated financial statements.
5
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KIDS MART, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER AND NINE MONTHS ENDED OCTOBER 26, 1996
(UNAUDITED, EXCEPT FOR INFORMATION AS OF JANUARY 27, 1996)
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(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 nine months
ended October 26, 1996, the Company incurred net losses of $14,454 and
$23,017, respectively. The third quarter and year-to-date net losses
reflected a provision for $5,247 recorded for the Company's store closure
plan (the "Store Closure Plan"), whereby the Company closed 97 stores (the
"Closed Stores") and reduced staff at its distribution center and
administrative offices. The Company's current liabilities exceeded its
current assets by $20,613 and it had a stockholders' deficiency of $15,930
as of October 26, 1996. Additionally, subsequent to October 26, 1996, the
Company continued to experience operating losses and is in violation of
covenants under its credit facility with Foothill Capital Corporation
("Foothill"). These factors, among others, make it unlikely that the
Company can continue as a going concern.
In response to these conditions, the Company has taken steps to reduce
expenses and increase liquidity. The Company, among other things, has
closed 19 stores upon the termination of their leases in addition to the
Closed Stores, has entered into a sale/leaseback transaction whereby it
sold certain equipment to a leasing company for $288, and leased it back
under an operating lease for 24 months, has entered into an agreement with
a vendor to convert amounts payable to this vendor to common stock, is
renegotiating its loan covenants with Foothill, has issued $1,659 of
unsecured convertible promissory notes (see Note 6), and is exploring
various interim and permanent financing opportunities with 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 Foothill and payment
terms with its vendors and landlords, to obtain immediate interim and
longer-term financing, and ultimately, to attain profitable operations.
If the Company is unable to arrange immediate financing, Foothill has
indicated that it will not continue to fund obligations incurred in the
normal course of business, including payroll obligations. Despite its
on-going efforts, management believes that it is unlikely that immediate
financing will become available to the Company under its current financial
circumstances and that, therefore, it is likely that Foothill will
immediately cease to finance the Company in the normal course of business.
In such event, management will recommend that the Company file a petition
for reorganization under Chapter 11 of the Federal bankruptcy laws. Based
upon recent discussions, management believes that, in the event of such a
filing, the Company will have debtor-in-possession financing made
available to it from Foothill and/or other financing sources.
6
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KIDS MART, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER AND NINE MONTHS ENDED OCTOBER 26, 1996
(UNAUDITED, EXCEPT FOR INFORMATION AS OF JANUARY 27, 1996)
- -------------------------------------------------------------------------------
(Dollar amounts in thousands, except per share amounts)
Moreover, it is possible that three or more of the Company's creditors may
join in an involuntary petition against the Company under the Federal
bankruptcy laws. There can be no assurance that if a voluntary or an
involuntary petition is filed by or against the Company, that the Company
will be able to successfully develop a consensual plan of reorganization.
2. SUMMARY OF ACCOUNTING POLICIES
The Company is a retailer of children's apparel. It operated a chain of
180 specialty children's apparel stores in 18 states as of October 26,
1996. As of December 30, 1996, the Company operated 146 stores. 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 presented herein 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.
Consolidated statements of operations and cash flows for the nine months
ended October 28, 1995 have not been presented as such financial
statements include the results of operations and cash flows reported in
the Disputed Financial Statements (hereinafter defined). The Disputed
Financial Statements include the consolidated statements of operations and
cash flows for the period from January 29, 1995 through May 31, 1995.
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."
Further, a consolidated statement of operations for the quarter ended
October 28, 1995 has also not been reported. The Company is unable to
report the consolidated statement of operations for the quarter ended
October 28, 1995 because Woolworth has not been forthcoming in providing
the Company with necessary financial information. Woolworth is in
possession of the financial information because it had been performing
certain financial services for the Company pursuant to a transitional
services agreement during this period.
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. Further, as
of the date of this filing, Woolworth has not provided the Company with
the necessary financial information in order for the Company to complete
the consolidated statement of operations for the quarter ended October 28,
1995, despite repeated requests by the Company for such information to be
provided. The Company intends to include the Disputed Financial Statements
and the consolidated statement of operations for the quarter ended October
28, 1995 in an amendment to the Company's Quarterly Report on Form 10-Q
for the
7
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KIDS MART, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER AND NINE MONTHS ENDED OCTOBER 26, 1996
(UNAUDITED, EXCEPT FOR INFORMATION AS OF JANUARY 27, 1996)
- -------------------------------------------------------------------------------
(Dollar amounts in thousands, except per share amounts)
quarter ended October 26, 1996, when the Company receives them and the
information necessary to generate them, as applicable, from Woolworth.
3. MERCHANDISE INVENTORIES
Merchandise inventories included markdown reserves of $625 and $1,164 as
of October 26, 1996, and January 27, 1996, respectively.
4. RESERVE FOR STORE CLOSURE PLAN
During the third quarter of fiscal year 1996, management announced and
implemented the Store Closure Plan whereby it closed 97 stores and reduced
staff at its distribution center and administrative offices. The following
tables set forth the provision recorded in connection with the Store
Closure Plan, and the reserve for the Closed Stores as of and for the
quarter and nine months ended October 26, 1996.
<TABLE>
<CAPTION>
Provision for Reserve balance at
Store Closure Plan October 26, 1996
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<S> <C> <C>
Estimated liability for lease
termination costs $ 3,196 $ 3,196
Write-off of Closed Store
property and equipment 1,227
Other 824 724
---------- ----------
$ 5,247 $ 3,921
========== ==========
</TABLE>
5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consisted of the following
as of the dates indicated:
<TABLE>
<CAPTION>
October 26, January 27,
1996 1996
- -------------------------------------------------------------------------------
<S> <C> <C>
Accrued payroll and related expenses $ 701 $ 1,114
Accrued advertising expenses 241 810
Accrued sales tax 240 603
Other accrued expenses 1,256 2,019
- -------------------------------------------------------------------------------
Total $ 2,438 $ 4,546
===============================================================================
</TABLE>
6. SUBSEQUENT EVENTS
On November 18, 1996, the Company issued $1,509 of unsecured convertible
promissory notes (the "Notes") pursuant to Regulation S and Regulation D
promulgated under the Securities Act of 1933, as amended. The Notes, which
are due one year after the issuance thereof, bear interest at 8%, and are
subordinated to the Company's credit facility, as amended, with Foothill.
Each Note is convertible, in whole or in part at the holder's option, on
or after the date which is 40 days after the date the Note was issued,
into shares of the Company's common stock at a price per share of 65% of
the price of the common stock on the day prior to conversion, not to
exceed $1.00 per
8
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KIDS MART, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE QUARTER AND NINE MONTHS ENDED OCTOBER 26, 1996
(UNAUDITED, EXCEPT FOR INFORMATION AS OF JANUARY 27, 1996)
- -------------------------------------------------------------------------------
(Dollar amounts in thousands, except per share amounts)
share or be less than $0.05 per share. On November 27, 1996, the Company
issued an additional $150 of Notes.
A portion of the Notes, $227, were issued to an investor group of which
Mr. Jeffrey Koffman, a director of the Company, is a member. Such Notes
were issued pursuant to Regulation D promulgated under the Securities Act
of 1933, as amended.
On December 31, 1996, certain Note holders requested to convert
approximately $20 of Notes into shares of the Company's common stock.
Based on the market price of the Company's common stock, the Notes would
convert at $0.05 per share into 392,400 shares. On January 1, 1996,
certain Note holders requested to convert $75 of Notes into 1,500,000
shares at a conversion price of $0.05 per share.
* * * * *
9
<PAGE> 10
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. 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 October 26, 1996, it
operated 180 children's apparel stores in 18 states. As of December 30, 1996,
the Company operated 146 stores. 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").
The Company's recurring losses, cash flow constraints, and loan covenant
violations under its revolving credit facility, as amended (the "Credit
Facility") with Foothill Capital Corporation ("Foothill") make it unlikely that
it can continue as a going concern. If the Company is unable to arrange
immediate financing, Foothill has indicated that it will not continue to fund
obligations incurred in the normal course of business, including payroll
obligations. Despite its on-going efforts, management believes that it is
unlikely that immediate financing will become available to the Company under its
current financial circumstances and that, therefore, it is likely that Foothill
will immediately cease to finance the Company in the normal course of business.
In such event, management will recommend that the Company file a petition for
reorganization under Chapter 11 of the Federal bankruptcy laws. Based upon
recent discussions, management believes that, in the event of such a filing, the
Company will have debtor-in-possession financing made available to it from
Foothill and/or other financing sources. Moreover, it is possible that three or
more of the Company's creditors may join in an involuntary petition against the
Company under the Federal bankruptcy laws. There can be no assurance that if a
voluntary or an involuntary petition is filed by or against the Company, that
the Company will be able to successfully develop a consensual plan of
reorganization. See "--Liquidity and Capital Resources."
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 nine months ended October 26, 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 $14.5 million and $23.0 million for the
quarter and nine months ended October 26, 1996, respectively. The third quarter
and year-to-date net losses for 1996 reflect a provision for approximately $5.2
million incurred in connection with the Company's store closure plan (the "Store
Closure Plan"), whereby the Company closed 97 stores (the "Closed Stores") and
reduced staff at its distribution center and administrative offices. The Company
received the consent of Foothill to the Store Closure Plan. See "--Results of
Operations."
The Company reported net sales of $16.3 million and $63.7 million for the
quarter and nine months ended October 26, 1996, respectively. The Company
operated 180 stores as of October 26, 1996. The Company had a working capital
deficiency of $20.6 million and a stockholders' deficiency of $15.9 million,
respectively, as of October 26, 1996. The Company is in violation of its loan
covenants under the Credit Facility, and anticipates violation of other
covenants for the remainder of fiscal year 1996. These conditions raise
substantial doubt about the Company's ability to sustain operations.
10
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INTERIM AND PERMANENT FINANCING. On November 18, 1996, the Company issued $1.5
million of Unsecured Convertible Promissory Notes (the "Notes") pursuant to
Regulation S and Regulation D promulgated under the Securities Act of 1933, as
amended (the "Act"). On November 27, 1996, the Company issued an additional
$150 thousand of Notes. The Notes have not been and will not be registered under
the Act any may not be offered or sold in the United States absent registration
or an applicable exemption from registration requirements.
The Notes, which are due one year after the issuance thereof, bear interest at
8%, and are subordinated to the Credit Facility. Each Note is convertible, in
whole or in part at the holder's option, on or after the date which is 40 days
after the date the Note was issued, into shares of the Company's common stock,
par value $0.0001 per share (the "Common Stock"), at a price per share of 65% of
the price of the Common Stock on the day prior to conversion, not to exceed
$1.00 per share or be less than $0.05 per share. Based upon the price of the
Common Stock on the day prior to the date of this filing, upon conversion of the
Notes, the holders thereof would own, on a fully-diluted basis, approximately
81% of the Company's Common Stock. See "Item 5. Other Information --Change in
Control."
If the Company is unable to arrange immediate financing, Foothill has
indicated that it will not continue to fund obligations incurred in the normal
course of business, including payroll obligations. If the Company is unable to
arrange such immediate interim financing, and Foothill ceases to finance the
Company's operations, management will recommend that the Company file a petition
for reorganization under Chapter 11 of the Federal bankruptcy laws.
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 most of its 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 most
of these claims, individually, are not material, taken as a whole, the
successful prosecution of these claims would have a material adverse effect on
the Company's cash flow.
It is possible that three or more of the Company's creditors may join in an
involuntary petition against the Company under the Federal bankruptcy laws.
There can be no assurance that the Company will be able to reach a settlement
with its landlords and creditors, or that if an involuntary petition is filed
against the Company, that the Company will be able to successfully develop a
consensual plan of reorganization.
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 Service 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 details of the conversion process. 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.
11
<PAGE> 12
FINANCIAL CONDITION
The Company's working capital deficiency was $20.6 million as of October 26,
1996, as compared to working capital of $1.0 million as of January 27, 1996. Its
current ratio and debt-to-equity ratio were 0.30 and (1.87), respectively, at
October 26, 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 October 26, 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 nine
months ended October 26, 1996, based upon management's belief that the
possibility of such loss is remote.
Merchandise inventories decreased $9.9 million or 57.9 % from $17.1 million at
January 27, 1996, to $7.2 million at October 26, 1996. The decrease in inventory
was primarily the result of the Company's inability to make planned inventory
purchases due to cash flow constraints.
Pursuant to the Store Closure Plan, the Company transferred inventories from the
Closed Stores to the remaining open stores during the quarter ended
October 26, 1996. 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.
As of October 26, 1996, the average retail store inventory was approximately
$91.1 thousand. There can be no assurance that the inventory levels will not
drop below acceptable levels in the future.
Property and equipment decreased $1.1 million, net since January 27, 1996,
largely as a result of $1.2 million of losses incurred on the write-off of
property and equipment of the Closed Stores.
Accounts payable increased to $14.8 million at October 26, 1996, from $5.6
million at January 27, 1996. This increase was partly offset by a $2.1 million
decrease in accrued expenses. 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.
On September 11, 1996, the Company entered into an agreement pursuant to which
one of its vendors agreed to convert $0.65 million of amounts due to the vendor
to 433,333 shares of 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 has the right to
have its nominee immediately installed as a director to the Company's Board of
Directors. As of the date of this filing, the vendor has not submitted the name
of a nominee for such purpose. Once installed, 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. As of the date of this filing, the shares of
Common Stock have not been issued and accordingly, are not reflected in the
consolidated financial statements as of October 26, 1996. The Company intends to
issue the shares during the first week of January 1997.
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.
12
<PAGE> 13
The Company is party to the 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 its terms. 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 these covenants and anticipates other covenant violations during
the remainder of fiscal year 1996.
During April, June and July 1996, the Company and Foothill amended the Credit
Facility. These amendments modified certain covenants, extended the term of the
Credit Facility 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 $6.00 per share as consideration for these
amendments. In conjunction with arranging the overdraft facility, the 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 Company was unable to complete the required financing by
September 30, 1996, and is currently in violation of this covenant.
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 which the Company is currently violating, 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.
At October 26, 1996, the Company had drawn down approximately $7.3 million at
10.25% under the Credit Facility and the overdraft facility. Approximately $4.9
million of the outstanding borrowing represented the loan balance based on
eligible merchandise inventory, as defined under the Credit Facility. There was
no additional credit available as of that date. Further, the Company had
borrowed $2.4 million and had no additional availability under its overdraft
facility as of October 26, 1996. At December 9, 1996, the Company had $5.9
million outstanding under the Credit Facility, including $0.3 million of
borrowings in excess of its $2.0 million overdraft facility.
The Company has experienced significant 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 and holiday seasons.
In order to sustain operations, the Company requires immediate financing. The
Company raised $1.66 million of interim financing through the issuance of Notes
in November 1996. See "--Introduction--Interim and Permanent Financing."
If the Company is unable to arrange immediate financing, Foothill has indicated
that it will not continue to fund obligations incurred in the normal course of
business, including payroll obligations. Despite its on-going efforts,
management believes that it is unlikely that immediate financing will become
available to the Company under its current financial circumstances and that,
therefore, it is likely that Foothill will immediately cease to finance the
Company in the normal course of business. In such event, management will
recommend that the Company file a petition for reorganization under Chapter 11
of the Federal bankruptcy laws.
13
<PAGE> 14
Based upon recent discussions, management believes that, in the event of such a
filing, the Company will have debtor-in-possession financing made available to
it from Foothill and/or other financing sources.
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 $14.5 million and $23.0 million on net sales
of $16.3 million and $63.7 million for the quarter and nine months ended October
26, 1996, respectively. The Company operated 180 stores at October 26, 1996.
Gross profit was $3.8 million and $21.5 million, and gross profit margin was
23.1% and 33.7% for the quarter and nine months ended October 26, 1996,
respectively. Gross profit was $7.2 million 34.6% for the second quarter ended
July 27, 1996. Gross profit decreased $3.5 million and gross profit margin
decreased 11.5 percentage points for the third quarter ended October 26, 1996
from the second quarter ended July 27, 1996. The most significant reason for the
decline in gross profit dollars, versus the second quarter, was the loss of
regular price sales resulting from inadequate inventory levels, and the absence
of the flow of fresh product to stores. Purchases for the quarter ended October
26, 1996 were approximately $11.6 million, at cost, and $27.9 million at retail,
below planned levels. From late May through the date of this filing, the Company
has experienced severe cash flow constraints primarily due to its inability to
obtain adequate credit support from its vendors. The cash flow constraints have
severely impacted the Company's efforts to obtain adequate supplies of
inventory, with a resulting erosion in the Company's sales and gross profit
ratios. See "--Financial Condition."
Selling, general and administrative expenses were $11.9 million and $36.4
million for the quarter and nine months ended October 26, 1996, respectively.
Selling, general and administrative expenses were $12.3 million for the second
quarter ended July 27, 1996. During the quarter ended October 26, 1996 the
Company incurred significant one-time charges resulting from legal and
professional fees and expenses associated with its information systems
conversion, respectively. In addition, due to the timing of implementation of
the Store Closure Plan, the Company incurred normal selling, general and
administrative costs on the Closed Stores for part of the third quarter.
Depreciation and amortization were $0.4 million and $1.4 million for the quarter
and nine months ended October 26, 1996, as compared to $0.5 million for the
quarter ended July 27, 1996.
Interest expense was $0.7 million and $1.5 million for the quarter and nine
months ended October 26, 1996, as compared to $0.4 million for the quarter ended
July 27, 1996. The Company wrote-off $0.2 million of deferred finance charges
during the quarter ended October 26, 1996.
During the quarter ended October 26, 1996, management implemented the Store
Closure Plan whereby it closed 97 stores and reduced staff at its distribution
center and administrative offices. The Store Closure Plan required a charge to
operations of approximately $5.2 million, principally related to store rent
liability, closing costs, and separation pay. The Company 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
14
<PAGE> 15
aggregate rent liability for the Closed Stores is approximately $13.2 million
and the average remaining lease term is approximately 27 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.
15
<PAGE> 16
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 October 26, 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 nine months ended October 26, 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
$227 thousand of the Notes described in Part I hereof were sold to an
investor group of which Mr. Jeffrey Koffman, a director of the
Company, is a member, pursuant to Regulation D promulgated under the
Act. See "Part I. Item 1. Management's Discussion and Analysis of
Financial Condition and Results of Operations--Introduction--Interim
and Permanent Financing."
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
16
<PAGE> 17
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
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, and attain credit
support from its vendors, failure to negotiate acceptable payment
terms with vendors and landlords, and failure to negotiate waivers or
amendments to loan covenants.
CHANGE IN CONTROL. Pursuant to the issuance of Notes on November 18
and November 27, 1996, the holders of the Notes will have the ability
to convert the Notes into shares of Common Stock at a conversion rate
per share equal to 65% of the price of the Common Stock on the day
prior to conversion, not to exceed $1.00 per share or be less that
$0.05 per share. Tusk Investments, Inc., a British Virgin Islands
corporation ("Tusk"), holds $650 thousand of the $1.66 million of
outstanding Notes. Assuming all Notes were converted on December 30,
1996, Tusk would own, on a fully-diluted basis, approximately 32% of
the Company's Common Stock. As a group, the holders of all the Notes
would own approximately 81% of the Company's Common Stock.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None.
Exhibit 27 Financial Data Schedule.
17
<PAGE> 18
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: 31 December, 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
18
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<PERIOD-START> JAN-28-1996
<PERIOD-END> OCT-26-1996
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